
David Collum: We’re Now Stuck In A Global Game Of Tetris
Whether or not you've had time yet to plow your way through David Collum's excellent 2014 Year in Review, our annual podcast with Dave always brings additional color to light — and this year's is no exception.
To me, the global economic theme is existential risk. That's a phrase I use repeatedly throughout my Year In Review. Things now seem to be coming to a head.
A metaphor that I came up with, that I just love because I know the game well, is that we're engaged in a global game of Tetris. For those unfamiliar with the game: you place these pieces methodically, and then the game starts accelerating. You start placing pieces faster and faster, until you reach some point where you simply can no longer successfully place the pieces in time.
And it feels like the authorities, the monetary authorities, the geo political authorities — all of those people who are really calling the shots around the globe –are playing that game, and it's accelerating now.
The end of the game is called 'topping out'. And I’m wondering when that topping out is going to occur.
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Chris Martenson: Welcome to this Peak Prosperity podcast. I am your host, Chris Martenson. Well, if you want to know where you’re headed you have to know where you are and that means you have to know where you’ve been. Continuing with our annual tradition we've got the best year-end review in the business thanks to today’s guest Dave Collum. For those of you unfamiliar with Dave, maybe haven't listened to last year’s podcast or read last year’s year-end review, he is a professor of chemistry and chemical biology at Cornell University where I got my MBA. We didn’t meet there, wish we had. In addition to his academic interest Dave authors this annual macroeconomic assessment titled "The Year in Review." It’s hands down as I mentioned the best synopsis of anything that mattered in the previous 12 months and boy there is a lot of stuff to cover. His latest "Year in Review" can once again be found on Peak Prosperity and I’m excited to have him with us now live in order to expand on his excellent insights. There is so much to cover. Dave, thanks for joining us again this year.
David Collum: Hey, it’s a blast. I love it. It’s just – I would do it just to sit around and chat with you for an hour, so.
Chris Martenson: I would do it just for that reason to talk with you because you really just have been capturing everything that has been going on and boy, so much. I don’t even know where to dive in. Let’s just start here – if you had to pick one, what is the biggest theme for you this year that really stands out in the economy? Let’s start with the economy.
David Collum: Interestingly, the economy is kind of holding up. It was like it was on life support or something all year. And so in some sense this year didn’t feel like the economy as much as other years, but with that said in a late season spectacular moment we got into it with the Russians and the next thing you know the price of oil is plummeting and no one seems to know what to make of it, but I think that will probably turn out to be an important event. I think it will be important economically. I think it will also be important geo-politically as well as militarily maybe. This is a big event.
Chris Martenson: I agree. I am having trouble saying there is much standing out economically particularly, but what I do see is this global theme that if I can put it this way, I wasn’t alive then but it feels like 1911, right? So people say "hey, we don’t really know what happened. An arch duke got shot. We are going to call it World War I that is why it happened. That was the reason." But in truth there were these pressures that had built up, so to me the big theme this year is this breakdown of relations with Russia that I still don’t understand. I don’t understand why it happened or what the end game is. There must be something else happening, but it feels to me like this whole plunge, plummet, crash in oil prices has to be connected to that in some way directly, but certainly it is indirectly connected because it is abusing all the oil exporters badly and Russia being a prime example. So as you look at that oil, let’s turn there because to me that is probably going to turn out to be the macro economic event of the year. Even though it is happening here in November and December. What do you see as behind the oil price collapse?
David Collum: You know, actually just to back out a second since I thought you wanted to keep me on the economy, let me just pan out a little bit and say to me the global economic theme is existential risk. And that is a phrase I use repeatedly throughout my year in review. There are just things that now seem to be coming to a head. A metaphor that I came up with that I just love because I know the game well is this game of Tetris, this global Tetris. When you play that thing you place these pieces methodically and then the game starts accelerating and you start placing pieces faster and faster and you reach some point where you simply can no longer successfully place the pieces. And it feels like the authorities, the monetary authorities, the geo political authorities all of those people who are really calling shots around the globe are playing that game and it feels like it is accelerating now. The end of the game is called topping out and I’m wondering when that topping out is going to occur.
With that said the energy is part of that game. That is one of the many facets of this year that just felt, felt like something big could happen. And so you know, you listen to the pundits on TV and they get the fact that it is about Russia. There is a lot of discussion about how the Saudis are trying to put our frackers out of business. I don’t think that’s it. I think it actually – I think it actually started with ISIS threatening Saudi Arabia and us being in a tiff with Russia, which in my opinion is our fault. So I agree with you. I don’t know what happened. This geo political situation we're in — I can’t even tell you a story about what happened, but it appears to have started when we popped the democratically elected government in Russia and then from there the Russians moved to Crimea.
The next thing you know, we don’t like that. And then the Saudis end up threatened by ISIS. And I think what we said to them — and this is speculation — I think what we said to them is "look here is what we will do. You talk down the price of oil; that will beat up Putin. We’ll take care of ISIS. We will call that even, right?" So the first thing that appeared in the oil sector in my opinion, the first thing that I spotted were the Saudis talking about where they would be comfortable with oil. It is contemporaneous with us starting to sort of sabre rattle against Russia. The Saudis are not comfortable with lower oil prices. They say that for a reason and the reason seems patently obvious to the Crimea problem. Yeah, maybe our frackers are knocked out but the price of oil was doing great. They were selling oil at a high price. So I don’t see how that makes sense.
Chris Martenson: Well, it doesn’t make sense. Here is the other thing to say that Saudi Arabia is interested in putting the frackers out of business. Saudi Arabia produces mostly heavy grades and sour grades of crude. So people often get confused because it is presented in the media as if there is "an" oil market, right? Oh, it’s just oil. Just one substance. It’s like saying water, fresh water. It’s this one thing. It’s not. There are all of these different grades and the truth is that the kind of grades that come out of the fracked area are really light, sweet grades and they are not in competition with Saudi Arabia at all. To have a refinery you have to build it and you have to build it for a very narrow range of crude grades that can be put through that thing. And so our refineries in this country are mostly geared for heavy and sour grades at this point in time. So we are still importing oil and we are still running it through our refiners. We've got all this stuff piling up. When they say in the Untied States "oh, we are interested in exporting oil again," what we are really saying is we are interested in exporting these grades of oil that we don’t even have any use for because we have so much of the stuff here. Because the grades are all wrong. Saudi Arabia is not in direct competition with the frackers because they don’t produce the same product. And that is an important point that really isn’t being talked about much yet.
David Collum: Yeah, boy you are much better at that stuff than me. I think that’s right. And I don’t think that the frackers ever were in any way threatening Saudi Arabia as you say. Interesting at some point in the next few minutes we should talk about whether they understood the collateral damage that would be done as we attempted to engineer a serious beating on Putin. Did we understand all the collateral damage that would be done? It’s not obvious to me that we understood that.
Chris Martenson: This is a great point. I believe — this is my personal view — that the people in the state department are political beasts and the people in the executive branch are political animals and that is what they know. And so geo politically it probably makes a lot of sense to go ahead and crush oil and see if you can really batter Putin a little further. Because the sanctions on his friends and advisors wasn’t really cutting it for some reason.
So when we look at that though, then you have to turn the page and look at the other part of the story. Already we have $150 billion of world wide projects, oil projects that have been yanked. Tar sands, deep water, now shale projects are being yanked. So we are looking at that and the thing those political animals and beasts don’t understand is A.) you need oil to run an economy and B.) the world has spent since 2005 $3.8 trillion and gotten exactly 0 more barrels out of the ground for their trouble. So we are on this treadmill in this story right now where we have to spend huge amounts of capital just to keep our oil quantities in place and that is all now at risk. And I don’t think the political animals really get that. I certainly hope people in the oil business are knocking on their door going "hey, hey no, you have to understand something here, this industry can’t take a year of these prices."
David Collum: And what do you bet they didn’t see the crisis in the high yield debt market coming, right? I think when they crushed Putin, when they went to crush Putin, which by the way and I talk a lot about Putin in this "Year in Review," but the idea of trying to hurt the Russians I mean cause pain these guys are tougher than nails, right? These guys survived the siege of Leningrad. You are not going to hurt them in a way that would hurt us if it was a quid pro quo. But do you think the guys in the State Department understood what would happen to our junk bond market when we crush Putin? I would be shocked if they saw that.
Chris Martenson: I don’t think they think in economic terms or energy terms or environmental terms. I don’t think any of that stuff really fits on their radar screens. I believe they are just purely political animals. And I see that written out again and again and again. Everything the justice department has and has not done. Everything the State Department has and has not done. Everything that Obama proposes and fails to propose. None of those make sense to me on economic terms, energy terms, environment terms, none of that. They are all just political maneuvers. But that’s how I see it.
David Collum: I think that’s correct. And I also think one of the things we witnessed this year was that Obama – you know I gave Obama a pass for a few years. I’m not a liberal democrat, so. I was not a Bush fan either and so I gave him a pass. I thought okay so liberals do have ideas that trump conservative ideas in some areas. So I was open to the idea. I think Obama is a bit of a sociopath and I have really turned on him pretty hard at this point. And I don’t think he’s up to the task of going against Putin. So meanwhile Obama is throwing his rhetoric that he thinks is so clever at Putin. And Putin is this incredibly tough ex KGB guy; he is not going to care about that. He doesn’t care what people think. And by the way his popularity rankings in Russia are probably five multiples of Obama’s here. Right? He is a popular guy in Russia. You’re not going to pressure him. They’ll eat less food. They’ll heat their houses less. They’ll take the beatings.
Chris Martenson: Absolutely. So I do think that I share with you this idea that Russia is a tough adversary. It is not as simple as oh, calling in some NATO air strikes and getting rid of Kaddafi and you know, feeling flush from that and running a little revolution in Egypt and getting somebody tossed out there and you know, doing a little crush action on Syria and whatever we have done in Iraq. I think the State Department had sort of gotten ahead of itself in believing that it really could go undertake regime change wherever it wanted to. And I think that’s what they’re after in Russia. And Putin has said as much, right? He has said they are going for regime change here too. Good luck with that; it’s not going to happen.
David Collum: They think they are going to get one. Putin is done. That’s what I don’t understand. So this whole battle with Russia looks to me like we just didn’t get – you know, why do I think… I don’t know. There was a guy named Meerscheimer who wrote an article that was just truly brilliant. It was brought to my attention. I have been ___[00:12:33] what Meerscheimer said was we wanted Ukraine to be more friendly to our needs, right? And I think at times our needs are kind of whimsical needs. This is not some sort of national security need; this is just what we want. And what we failed to calculate is Russia had to have Ukraine for his needs. Ours were wishes. His were needs. You’re not going to win that one, right? This is a losing fight. So we knock over a regime. We create a vacuum. Russians come running in in unmarked vehicles. I think we must have known that would happen but I don’t know what our end game was. It really seemed like a foolish thing. I am not going to criticize Putin for this. I get Putin’s response. He’s a mean guy. I don’t doubt that. But we elicited his response this time, in my opinion. I think history is going to be pretty punishing to our team on this one.
Chris Martenson: Well, I knew it was bad when both Gorbachav and Kissinger within two days of each other came out of their caves. Kissinger at least lives in a cave, I think, and said "hey, uh, let me give you a little diplomatic tip here." Kissinger basically said "if you don’t have the end in sight, you really shouldn’t be doing what you’re doing." Like he basically said exactly what you said, which is "I don’t think you guys know what you’re doing here." Because nobody can detect what the end game is. So massive uncertainty. Nobody seems to know what the game is. That is why I think it is like 1911. Nobody can explain — and I have talked to people who are very intelligent people who have been in the business, who have been in government and I have been asking the same question, which is "what is our game plan with Russia?" And nobody can say. Even when we say "oh we have put all these sanctions on Russia so that they will do something different" and at best nobody can tell me what the list is. Exactly what would they do differently?
And it was hysterical when they had that G20 meeting down in Brisbane and Harper comes up from Canada and says to Putin, "hey, you really need to get your troops out of Ukraine." And Putin is like "I don’t have any troops in Ukraine." And in this day and age with satellites that if you can’t show a picture and say "there are your troops. See them? See all those troops?" No one can produce the picture so there is — still at the level of the prime minister of Canada is going fact free in a confrontational way with another super power without any data is astonishing to me.
That to me is a larger metaphor for what I’m seeing in the markets as well. There is a lot of fact free sort of positioning and maneuvering going on. I have been extraordinarily bearish on these markets for a while. Not because I think they are necessarily going to go down. Although, I think they ought to in a lot of cases. But because they no longer represent reality to me in any way, shape or form.
David Collum: So the other answer to your original question is what do I pay attention to – I think I spent the majority of ATP in my brain worrying about the bond markets this year. It just, we are hitting multi-century lows and yields which as your readers already know means the prices of the bonds are at multi-century highs. And I actually put a list of yields by country in my review and they’re ridiculous. You are looking at these long duration bonds that are returning nothing. You've got currency risk, you've got default risk. I mean we are talking Spain at 3%, this is just crazy time.
Chris Martenson: And Italy at 2% on the 10 year.
David Collum: Yeah. Those are not investors. Those are either spectators or just pure sovereign interventions, and probably a combination. So the bond market I watched all year. And the best-case scenario — this is the horrifying part — the best case scenario is the market never collapses and you don’t get squat for yield forever. How is that possibly good? And then for the bond owners it is much worse from there, right? The bond owners can lose all of their principal and they can really get crushed. And it is not a retrievable crushing. If they get crushed that principal is gone. For the bond buyers, that would be the best case scenario. You and I probably we would love to see interest rates soar at some point and then we can scoop up the debris. But they are just going to resist that at all costs. So we have pulled all of our returns coming forward. So there is no return left. By the way, since equities are priced to the sky, according to the Case Schiller index, and bonds are priced out of the solar system, if we do have a bad event where things start dropping they are going to go simultaneously, unlike 2009 where bonds covered for stocks. You are going to have a simultaneous paroxysm, to use a Stockman term. And it is going to be so bad.
Chris Martenson: A theme we use at Peak Prosperity is this idea of "from the outside in," meaning that when markets start to go, they go at the periphery first. So in the bond market the periphery are these junk bonds, which I couldn't believe they have traded for over a year with either a four handle or a five handle, right? Four to five percent for junk bonds, right? And so as you mentioned before, this junk bond market is now having a little bit of a "come to Jesus" moment, right? It’s like "uh-oh, risk actually exists" and I will tell you that the 17% of junk bonds, which is a very large number, it is over $100 billion that are associated with the shale drillers is very much exposed to pure default risk at this point in time. And very, very rapidly unless they get access to being able to roll those junk bonds back over again. Every time those bonds come due you are going to see a default going forward unless oil prices rapidly tick up. But nobody had a sense of risk anymore. There was no risk. It was like it had been completely taken away. Central Banks through coordinated printing have apparently completely eliminated risk. That has to be a macro theme for 2014 that I think we'll look back on and go "wow, what were we thinking?"
David Collum: Yeah, and for several years now the term "risk" has been used synonymously with "return." And that is just is surreal to me. The phrase that I have been using off and on for quite a while now is that I think people seeking risk are eventually going to find it. And when put in that way you go "oh my God I haven’t thought of it quite like that." So when they talk about people going out on the risk curve, that is like walking the gang plank, right? And so they will find risk. And then they’re going to discover that it is called "risk" for a perfectly good reason and the bond guys are going to discover that it was a bond and it was so big that they couldn’t see it. I call it a caldera. I actually googled that. Best I can tell, I own that term. I am not sure it is that clever, but I was pleased. It's so big you can't even see the bulge. It’s everywhere. It is pervasive, but it is – it will go away. We know that. There is nothing in the history of markets that says when things get that crazy that they then stay crazy forever, right? It never happens because forever is too long.
Chris Martenson: We’re humans so we’re ruled by narratives. The main narrative that the Wall Street Journal, the Oval Office the CNBC, the whole machinery has been trying to run this one narrative which is "hey look, the economy is doing great. It has really recovered. We've got nice auto sales again." So that is one narrative. And then there is another narrative which is becoming increasingly obvious which is that well, we have this extraordinary wealth gap that is really just courtesy of the central bank printing money and preferentially shoving it into the financial sphere, which drives up financial assets. So the owners of financial assets preferentially become rich. It is not a mysterious process, except for Janet Yellen who came out and lectured us all and said "oh, are you experiencing a wealth gap? Well, you need to be a better entrepreneur. You should probably spend more on your kids and next time you should have wealthy parents." Thank you, Janet, for that little discourse of blame the victim. Love it. Where did you learn that? It was fantastic. Right?
But for 99% of the population of the United States, I think elsewhere as well, what I see is that the pie is no longer expanding like it used to, but the people who have access to the pie first, the 1% or .1%, they don’t know anything other than to keep taking more and more and more. So when the pie is not expanding and you have a small slice that is grabbing more and more and more of it, there is just less and less for everybody else. Wander over to statistics and you find things like food stamp usage and average hours worked and part-time jobs versus full-time jobs — all of those statistics make sense in a narrative that says the economy isn’t growing. It just isn’t. And what parts are there are being increasingly taken by this smaller and smaller cadre of people and that’s a theme that I think is starting to emerge here at the end of 2014.
David Collum: Well, it produces an angry bunch of characters. The other thing is you know, people like to say this is – there is valuation issues here, but it is not like the .com era. There actually is a fundamental difference that people are missing here and that is – and I talked – I remember talking to my dad about this. I said you know, all of these crazy companies that are being overbid, when this mess is over, and it hadn’t started yet, but we were convinced it would be over at some point. We will at least have a bunch of new technologies to show for the pain and suffering of getting overvalued and malinvestments. So we built out vast fiber optic lines we didn’t need immediately and we overpaid and stuff, but at least we know have fiber optic lines.
The current wealth disparity, the one that exists, it is not about the Michael Bells and the Bill Gates and the various tech guys, bio tech guys who are changing the world. It is pure — the rentier class, the pure moving of money class. Even the tech guys I don’t think are getting any richer. You can say "oh yea, what about Twitter?" Somehow Twitter just doesn’t feel like a smoke stack industry to me. I love it, but I don’t think that it’s – I don’t think that it’s so great. It should be a niche. It shouldn’t be the source of growth of industry. It doesn’t put more food on tables. It doesn’t do any of that.
And that wealth disparity is now so grand that we are in a guilded age now where you have these "let them eat cake crowd" and I think that is where – that ultimately there is going to be social unrest. And boy I spent a lot of time on Ferguson and Bundy Ranch and stuff like that too. I think Ferguson and Bundy Ranch are foreshadowing of major social upheavals going forward. By the way, I give credit to the Occupy Wall Street crowd. I think Ferguson stems from Occupy Wall Street and that the Occupy Wall Street guys were the first to figure out how to use social media to try to disrupt society enough to get their attention. And so I think – now you've got a situation where now imagine how many times over the following years some person is going to get abused by the police, right? Unimaginable number of times, right? That’s another theme.
But now you've got this mechanism where some kid gets wacked by the police — this has been happening steadily. But now all of a sudden you got 1,000 grumpy people they can go shut down the George Washington Bridge. They can go shut down infrastructure. They now can feel the power. These guys say "we've got sharp pitchforks now." It is not going to go away. We are going to get protests that are stupid. I’m not sure which ones are smart, which ones are dumb but we’re going to get them relentlessly because when someone is unempowered and then you give the this power, it is intoxicating too. I'm not saying it is right or wrong. I am just saying it is going to happen I think.
Chris Martenson: This is a general theme as the social mood darkens. We have seen anti austerity riots in Brussels. We have seen the mass protests in Hong Kong, which were for a greater, more representative form of democracy. We have seen the protests in Ferguson against unrestrained police violence and lack of accountability. All of those actually fit under a theme for me, which is again back to this idea that the pie just isn’t growing fast enough for both the 1% to take everything they feel they are entitled to and have enough for everybody else to feel like they got a piece. All of these are just representations of feeling like there is some inequity in the system. Whether it is social inequity, justice inequity or economic inequity, that is the theme. It makes sense. And so I think you’re right. I think as the people start to feel – it becomes okay to talk about that inequity, then you get sort of a dam burst. People come roaring out going "yeah, I have been a little grieved about this. I can talk about that now?" And I don’t know if the protests are useful or helpful or not, but I agree that Occupy Wall Street, you know, they very quietly had to put up with a whole lot of police abuse and agent provocateurs and having their faces scanned and their cell phones swept electronically and had records made of them. They had to go through all of that, right? Mostly under the radar. It took a while for the press to catch on and go, "hey, that is kind of goofy stuff you've got going on there."
David Collum: Yeah. So I spend a lot of time channeling Matt Tiabin, Rodney Belko’s books that they wrote on sort of how the lower class is treated by the police. And Belko talking about the militarization of the police. By the way the Belko book The Militarization… what’s it called? Anyway, Rodney Belko look it up something about the militarization of the cops, is such a disturbing book because he tells the story of the increase in the military flavor of the police and it just doesn’t feel like hyperbole. It feels like he is being factual and controlled. And it’s terrifying. And a guy who I think needs a hat tip, and maybe you should have him on as an interview, Michael Krieger. He used to blog about economics. He has just gone totally social. Totally civil liberties. I think it is like he is being drawn by the tractor beam here. He has been out there just screaming. And fortunately, Zero Hedge picks up on him and posts his stuff so it gets some legs. I would like to throw a big heads up to read Michael Krieger’s Liberty Blitz because he is out there fighting this fight. Best I know out there doing this.
Chris Martenson: Yup. I have read his stuff. It is very good. It is almost like there is an outrage du’jour. Every day there is something crazy. Whether it was Citibank sneaking in a provision into the CRomnibus spending bill to put American taxpayers on the hook for whatever derivative bets the banks can scheme up. You know it is just crazy every day there is a little insult like that and it is almost too fast to keep up with at this point. And so there is a little – I have a sense of just sitting back and watching this and going alright, there is very little positive to sort of cling to here politically in my own country that I can believe in. So probably just best to watch this.
And so let me sneak back to this idea of the narrative. So one of the narratives is with equity prices being crammed all time new highs, I think we had 54 separate incidents of hitting new highs in the year 2014, which by the way I think 1929 was the last year we had so many new highs in a single year. And that should have really been very, very helpful to anybody with a portfolio. One of the mysteries to me, Dave, is the state and municipal pension systems — every time I crack open the covers and look into those I am expecting to see them saying, "oh, we are very healthy now. We are back to fully funded" or something and that is just not the case. And what is the explanation for that?
David Collum: I actually think that is logical because what happens is after they crushed their portfolios in ’09 I think a reasonable individual would say, "you got to go back to acting like a pension fund. You got to go back to acting conservative in a proper fiduciary person and quit doing this crazy derivatives garbage you are doing." The problem is they end up doing it at the bottom. I think to say "oh, you just lost all of our money, now you have to speculate some more" is less rational. So the idea that they sell at the bottom, that is not foolishness. That almost had to happen I think. Someone had to step in and say "stop being crazy." So then no one saw the Fed coming at the level that they showed up, right? You and I remember when they bailed out — when they dumped $30 billion, what was it, Bear Sterns. It took my breath away. "$30 billion, are you kidding?" You can find $30 billion under the cushions now. That is such a tiny quantity of money compared to what they actually ended up doing. I don’t think anyone would have believed they'd do that. So
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