Quick Disclaimer

The following is a transcript of recorded content. Please note, these transcripts are not always perfect and may contain typos. If you notice any major mistakes, please feel free to report them by opening a Technical Support ticket under the Help menu at the top of the screen.

Full Transcript

Chris Martenson: Welcome to this Peak Prosperity podcast everybody. It is December 5, 2017. I am your host Chris Martenson. Today we are going to be talking about the massive financial bubbles that currently envelop the earth.

You have heard me talking about them ever since the crash course was released in 2008, and on podcasts ever since. I have been writing about them since 2007, when I personally began shorting the U.S. housing bubble in earnest.

More recently, I penned pieces titled The Mother Of All Bubbles, and When Bubbles Burst. Truly, there is nowhere to hide anymore after so many years of coordinated global central bank action. Our guest today is someone I have followed for years. Whose writings were instrumental in helping me formulate the economic portion of the crash course.

His name is Doug Noland. I first became acquainted with his writings and ideas when he worked for the Prudent Bear funds where he worked for sixteen years with David Tice. In the ten years prior to that, Doug worked as a short side trader analyst and portfolio manager during the great '90s bull market. If there is ever a crucible for honing one's skills ,it's in locating profitable shorts in a rising market.

Doug now works with David Mcalvany at Mcalvany Wealth Management. I have been on David's program a few times. He is a class act and someone I very much respect. The summary here is that Doug has 30 plus years of experience, and is a great analyst, and commentator of credit cycles and dynamics, which makes him one of the very best people to talk to here at the heights and possibly ends of one of the greatest credit bubbles in all of human history. Doug, welcome to the program.

Doug Noland: Hi Chris. Thanks for having me on. Those are very kind words. Thank you very much.

Chris Martenson: You're more than welcome. Seriously, I mean every word of it. I have been following you for years. Your writing is just…. I put it. It's kind of like you do for credit bubbles. What John Hussman does for equity valuations for me. You put the numbers to it. You put the context.

We have to know where we are historically. Doug in your view, did I overdo it maybe and engage in a little bit of podcast hyperbole when I said, "One of the greatest credit bubbles in all of human history?"

Doug Noland: Chris, I think you referred to it as the mother of all bubbles. I refer to it as the granddaddy of all bubbles.

Chris Martenson: Alright.

Doug Noland: No. I agree completely. Yeah. The bubble has gone to the heart of money and credit. It has gone global. As you mentioned, it's basically across all asset classes. This is a deeply systemic bubble. I feel when this bubble bursts, that is finally when, yeah, and we kick the can down the road as much as we can. There will be serious problems to deal with.

Chris Martenson: Now, I want to talk about the serious problems. But if just to continue setting the stage for listeners here. If I have interpreted you correctly, and what we're really facing. It's not say a bitcoin bubble. People are saying there is a clear exponential or hyperbolic sort of an increase there. Or, maybe a housing bubble as we're seeing in Melbourne, or Toronto, or London; or, maybe even an equity bubble, but a credit bubble. Help us understand what a credit bubble is? Why these other bubbles are just sort of bubblets or derivatives of the big one?

Doug Noland: Sure. I really dove into bubble analysis back in the early 1990s. I was convinced that finance was fundamentally changing with the advent of asset backed securities and mortgage backed securities. The GSE, and Wall Street finance, and all of the derivatives, we were basically changing the way finance was created.

The old model where you had banks creating credit. Bank credit was limited by reserving capital requirements. That was thrown out the window. We now had unfettered credit growth through the market based credit. I started writing my blog at the end of the 1990s. I was convinced that once the central bank realized that this was this new experiment in finance, they would recognize that it was unstable.

They would move to it to rein things in. The way it ended up is that experiment in finance basically failed. It failed first with the collapse of the technology bubble. Then, with the collapse of the mortgage finance bubble, that model new finance basically failed.

What the Federal Reserve did and then the central banks did. They started an experiment in central banking with the class of interest rates and all of the quantitative easing, and buying all of the debt, and basically creating new money. That experiment with central banking was trying to stabilize the unstable finance.

As we have seen especially over the last eight or nine years, that has ended up with central banks creating what, ten, 12, and 14 trillion dollars worth of new money. Interest rates have stayed low. That is what has really led to this global bubble. It's just a complete mispricing of finance. Back through the mortgage finance bubble period, I used to talk about the moneyness of credit where basically we were transforming and Wall Street was transforming all of this risky credit into perceived safe money like AAA rated securities. That was through the GSE guarantees and the implied guarantee by the government.

What I have said over the last eight or nine years. We have moved it. Instead of the moneyness in credit, it's called the moneyness of risk assets where basically central banks are back stopping liquidity and basically the prices of risk assets. They have collapsed interest rates. They have force savers out of savings and into the risk markets.

That is how it becomes deeply systemic. That's how these pricing distortions, and the really significant market misperceptions are throughout the markets at home and abroad. Basically everyone believes that you can buy higher yield, junk debt, or a structured finance.

The Fed will ensure the markets are liquid. Why not write market insurance? Why not write derivatives and sell derivatives, and take those proceeds like writing flood insurance during a drought? That has been part of this whole short volatility trade.

That has created all of this cheap insurance. If the market insurance is so cheap, why not go out and take a lot of risk, and put on leverage, and run these aggressive strategies? If you know it's so easy to go out and hedge yourself. Unfortunately again, and the granddaddy of all bubbles, I can't believe it's gone on this one long.

In fact, if you recall back Chris, in 2001. The Fed came out with an exit strategy. I know. I titled one of my bulletins at the time "No Exit." Because I didn't believe they would actually wind down that balance sheet that they bloated during the crisis.

But, back in 2011 when they were talking exit strategy, I didn't realize they were going to double their balance sheet again to 4.5 trillion over a few years. Anyway, I think this has just gotten away from them. It has gotten away global central bankers. It has certainly gotten away from the Chinese with their credit bubble.

Basically a bubble, this is a long winded answer to your question. A bubble is a self-reinforced, a self-reinforcing inflation that in the end is unsustainable. That's the deal with credit bubbles. As long as you continue to create more credit, they look sustainable.

But, at the end of the day, that credit is suspect. Especially late in the cycle, it's very risky credit. If the market turns on that credit as we saw in 2008, then the bubble is extremely vulnerable.

Chris Martenson: Now, how far back Doug do we have to rewind this to figure out where the mistakes came? Einstein to paraphrase said that compounding is one of the most powerful forces in the universe. Well, in my analysis and I think yours as well. The central banks and it's beginning under Greenspan in the United States. It started compounding errors.

One of the prime errors that I can detect is when we suddenly convinced ourselves that we could grow our credit markets at twice the rate that our GDP, our gross domestic product was growing; which I'll use as a proxy for income. Not a good one as we all know because a hurricane like Harvey can come and ruin a city for awhile.

That counts as a positive in that model. GDP. does a very poor job by mistaking income and balance sheet actions. But at any rate and leaving that aside, let's just say to me that was the ultimate, almost cartoonish error that was made. It was falling into this thought the idea. That we could compound our debts at twice the rate of income.

By my measures and up through 2000 itself; and it has only accelerated since then. We were compounding our debts, our total credit market debt. For people listening, total credit market debt; that is auto loans, and student loans, and all household debt, and corporate debt, the federal, state, and local, all of that. Everything you can call debt and not liabilities.

This isn't unfunded or underfunded pensions and entitlements. Just debt, those were compounding at almost nine percent, 8.9 percent per year starting in 1970, and then carrying through to 2000. That's a 40 year run.

Meanwhile, GDP, even nominal GDP was compounding at about six percent. Or, our real GDP was compounding it about four percent during that period or roughly half. Just to me, and I don't know if it needs to be anymore complex than that? That is just a grade school error. Isn't it?

Doug Noland: Yeah. This gets back to, I call it. It was called this historically. It's inflationism. There is this view at the Fed. That as long as you continue to have the two to three percent inflation, then you can always inflate your way out of debt problems.

I think their view – they got very complacent. They weren't fearful of these periods of compounding debt. Because they thought, "Okay. If there's stress in the system, then we can just increase the inflation rate, and grow our way out of trouble." That's just a deep flaw of the whole notion of inflationism.

Definitely, I mean, we can go all of the way back to the '70s, and taking the dollar off the gold standard. We can do all of that. But I think the biggest mistake started after the stock market crash in '87. That is when we started to see the growth in portfolio insurance and junk bonds, and all of these more sophisticated Wall Street instruments, derivative markets, et cetera.

Instead of the Fed moving at that point, and saying, "Okay. This finance was unstable," after the crash in '87, Greenspan basically assured the market. They would stay liquid. They would reliquefy the market. That changed market dynamics profoundly.

All of the sudden the market realizes. Okay. The Fed is there to backstop liquidity. Then, you're off and running. Then after that, we saw the excess in huge credit growth in the late '80s, and the Milken era, and Boesky, and the M&A. It's almost hilarious now to think back.

Because the '80s were referred to at the time as the decade of greed. Little did we know what was going to unfold after that. But that really set in motion that the Fed would accommodate excesses. If there were any problems in the system, then the Fed would come out and bail the system out again.

We saw that in early 1990s after the excesses of the late '80s. You had the bursting bubble. Then, the Greenspan and Fed at that point manipulated the yield curve, and collapsed short-term rates, and provided this big margin for banks to recapitalize themselves after the coastal real estate collapses. That had just invited hedge funds to come in and leverage, borrow short and leverage long, and longer or dated higher yielding securities. That set off the next bubble, right?

Then, the bond bubble burst in 1994. Then, you have Fannie and Freddie come into the market and act almost like central banks, and aggressively expand their balance sheets, and reliquefy the hedge funds that were in trouble. Then, you have the Mexican bailout. That fed the bubbles in Southeast Asia. Then, they burst.

Then, the Russian bubble collapsed in 1998. Then, there were more bailouts in the committee to save the world. Each time the bubble was bigger. Then, the government involvement in the rescue or the bailouts were even bigger. It has just conditioned the markets.

You can expand credit as much as you want and leverage as much as you want. The Fed is there to make sure the markets are liquid. It's just a very dangerous dynamic. It's not the way capitalism is supposed to operate.

That is kind of how we got to where we are today. It started decades ago. That is part of the issue also, Chris. Today everybody thinks this is normal.

Chris Martenson: Yeah.

Doug Noland: They think 2008 was the 100 year flood. We don't have to worry about that again. If there is an issue that comes up, global central bankers are on the case. That is always I think the kiss of death for a market. That is what ensures the bubble gets out of control.

It's this view that somebody out there, or the central banks won't allow a crisis. We heard that. Russia and that the West will never allow a collapse in Russia. Washington will never allow a housing bust, right.

That market misperception always leads to the excesses. It will ensure at the end of the day you have a very dangerous bubble.

Chris Martenson: There are several things you need to have a bubble. That misperception is one. Maybe it's too early for the postmortem. But, it annoys me that Greenspan is skating off into history as a maestro in some people's eyes when I viewed him as somebody who completely misinterpreted the role of derivatives.

He somehow thought that they had space launched risk into outer space and never to be seen again. They achieved escape velocity. But instead, it's sort of like there is a second law of thermodynamics for risk. It's neither created nor destroyed. You can just transfer it for a little while. But, it still sits there.

Of course, it came roaring back with the housing bubble. But here at this point in time, I think the biggest error has to be that everywhere and always…. Listen, bubbles can form in a variety of things; tulips, railroads, swampland, and houses. People look at those and say, "Those were kind of unique things to those individual things that the bubbles were focused on."

But in truth, there is no bubble I can find. Maybe you have different data. That it could have happened without credit being freely available. I can't find a bubble that existed purely just because people were using hard earned savings or actual formed capital. It required credit.

As we look at this large sweep of history, and we say, "Wow, these guys had this idea," and gals now. That we could just continually increase credit forever into infinity. That is just our model. This is how it's going to work. This really feels like a really extremely defective idea to me.

The astonishing thing to me was it clearly broke apart in 1998. It broke apart again in 2000. It broke again in 2007. Here we are repeating literally the same mistakes except this time everybody has invested their hope in the idea that the relatively small number of people appointed to sit around the mahogany tables at various central banks. These people are going to get it right this time. Don't worry, nothing bad can happen anymore.

Doug Noland: Yeah. Bubbles, they're fascinating dynamics. As you said, there has to be a credit component. Under every bubble, there is some expansion of finance. You're expansion of credit. That is what creates this new purchasing power.

It goes in. It's going to buy an asset. That asset price goes up. The higher asset price entices more people to come in and leverage that asset.

It's self-reinforcing. As I said at the end, it's unsustainable. This is a bubble in finance, right. We can say a bitcoin. We can say tech stocks. By the way those are almost like a consequence of this bubble overall in finance. That's global finance.

Greenspan was key to this. I talked about the '87 stock market crash, and also this promise of liquidity, and this assurance. This guarantee of underlying liquidity. You mentioned derivatives. Derivatives are key to this. Because derivatives, basically that market functions on this assumption of liquid and continuous markets.

Because a lot of the people that write market insurance, it's not really insurance. They don't set reserves to the side for when there is a market problem. They can pay like you would a casualty loss on an auto accident. That is an insurable event. Market events are not random. They're not independent.

They're really not insurable. Whoever writes this flood insurance, they plan one way or the other to offload this risk to someone else. They plan, if they have to hedge their market risk that they' have written. They are going to go out and dynamically hedge their risk; which basically means selling into a down market.

Well, that's fine. It works great as long as everyone assumes the markets will always be liquid. We have this myth that all of this market insurance is really real. I think this market insurance, and this overall market insurance marketplace is key to the whole world wanting to take a lot of risk.

I come back also to this flaw in understanding that Greenspan had. He used to say, "Well, you can't have a national real estate bubble because real estate markets are local." You can have local bubbles. But, you're not going to have a national real estate bubble.

My response back then was I'm sorry. The issue is a national bubble in mortgage finance. That is why I never called it the housing bubble. It was the mortgage finance bubble. That was the mispriced mortgage credit and unlimited mispriced mortgage credit. It's throughout the whole system.

Okay. That's why it was a national and in many ways an international bubble. When you have these fundamental mispricings of unlimited finance globally, that is how you get these distortions. I also argue Chris that it's very interesting dynamic. The more systemic a bubble, the less obvious it is.

The tech bubble in the late '90s, that was pretty conspicuous, right. But, when the bubble burst, it was not isolated. But, it was relatively contained within the technology sector. It didn't have devastating impact on the whole economy.

The mortgage finance bubble, which was much more systemic. Most people didn't see it. In hindsight, they say they saw it. But they didn't at the time. I can assure you. But, it was much more deeply systemic.

This one is so deeply systemic, people just don't see it. Because basically we're inflating and distorting all of the markets. Nothing looks extremely unreasonable to most people. But in the end of the day, the finance is deeply unsound and unsustainable. I would argue.

Chris Martenson: Now, one of my favorite current statistics for that is a junk debt in Europe, which is now according to a Financial Times article from a few days ago reportedly trading at or just below a two percent yield. This is for junk debt. For people who don't know what that is. This is debt that has been issued by companies whose prospects are particularly poor.

They have got some issues. This would be the equivalent of your totally unreliable drunk Uncle Vinny who has never paid a dime back in his life; and lending him more money. Your chance of getting it back, not good. These are really poor prospect companies trading at two percent with a ten year U.S. Treasury yield at 2.3 percent roughly.

I don't know exactly where it is at this moment. But you call it 0.3 percent higher. The junk debt in Europe, that now we have an implied default rate of less than zero. That means the market is priced European junk debt.

Your drunk uncle, and I said. He has a less than zero chance of not paying you back. Absolutely astonishing and what are the chances Doug that there are some losses somehow in some malinvestment baked into that statistic?

Doug Noland: There will be losses. Of the global bubble, I think European debt is about the most conspicuous. Yeah. The junk debt, the European junk debt is two percent. Why is it at two percent? Because the ECB is buying large amounts of corporate debt. The ECB has kept rates either at zero or negative. The perception is that the ECB will keep those markets liquid.

With that perception, why not try to get a little higher yield? I would argue though, Italy at 1.7 percent today, a yield, and ten-year Italian bonds. Italy rapidly approaching 135 percent on government debt to GDP. That debt will not get paid back. But yet, the market will hold that debt at 1.7.

I think this is debt that has traded over seven percent yield back in 2011 and 2012. Here it is today at 1.7 I mean, and just a growth mispricing of a huge debt market. Italian debt, there is over a trillion dollars of Italian debt out there. Yeah. It's staggering, the excesses that have unfolded in European debt across the board. That's junk and sovereign.

Chris Martenson: Now Doug, I pick up your excellent ratings at creditbubblebulletin.blogspot.com. I am looking here at one of your weekly commentaries from Saturday November 4th.

Opening line, I want you to explain this to people. You say, "… Of the diverse strains of inflation, asset inflation is by far the most dangerous." Why is that?

Doug Noland: Yeah. I have to credit the great German economist, Dr. Kurt Richebacher for this analysis. I had the good fortune. I started reading the Dr. Richebacher's monthly newsletter back in 1990. I fell in love with the quality of his analysis. I was fortunate to help him with his newsletter for, I think five years that began back in the '90s.

Chris Martenson: That's great.

Doug Noland: Yeah. I mean, he just was just a great, a brilliant guy, and a great thinker of Austrian economics. He talked about this a lot. Okay. You get back to credit. Credit is key. If you can see an expansion of credit, that's an expansion of purchasing power. Then, it's a matter of trying to understand where that purchasing power is going? What the impact of it is? What the inevitable consequences are of that credit inflation?

What he argued; I agree completely. Consumer price inflation, that is one of many different types of inflation, right. You can have an inflation in consumer prices. You can have an inflation obviously on asset prices. If you have too much credit and excess purchasing power, you can trade deficits and current account deficits.

You can have an investment boom. You can have many variations of credit inflation. What he said. What he believed was that consumer price inflation was probably the least dangerous of those.

Because it was the most easy to deal with. There is a constituency out there that can recognize consumer price inflation. Say, "Wait, we don't want to have too much inflation," so they demand that the central banks tighten.

Let's say and like we saw with Volcker and the Volcker bet where they put the screws to be economy to get those inflationary biases wrung out of the economy. Well, Dr. Richebacher and I certainly argue today that asset inflation is much more dangerous.

Because there are no constituency. Indeed people love asset inflation. Who is complaining about asset inflation today? There were some complaints after the asset bubbles burst in 2000 and 2009. But after people start to make money in the market, they forget about that, and just bring on more asset inflation.

This type of asset inflation, not only is it self-reinforcing. It leads to significant distortions and investment. If you allow this inflation for too long, you will have deep distortions in the economic structure. Those are very dangerous as we learned and not that many years ago. As we have forgotten, but that is why asset inflation is so dangerous. Because no one will rein it in. The inevitable structural impact can be negative and take years to rectify.

Chris Martenson: We now know that the European Central Bank intervened along with the Bank of Japan in January of 2016, and early February to help prevent a market decline from going any further. We also saw a very odd and for me difficult to reconcile blast higher after the surprise Trump election. It started. The Dow was off 2,000 – I mean, sorry, 1,000 points by I don't know 2:30 in the morning.

Then, by open, it was almost green again. How likely is it in your mind that there was some help provided to falling markets there in the early Wednesday morning after the Trump surprise? More broadly, do you believe that these central banks are so scared of the Franken markets they've created, that they are now intervening covertly as well as overtly?

Doug Noland: It wouldn't surprise me. My analysis, I kind of ignore for the most part the covert t aspect of this. I focus on what they tell us they're going to do. But, if they're going to tell us that they're going to buy trillions of dollars worth of debt, and create trillions of dollars of money, and create negative interest rates; assure the markets that they're backstopping them.

I don't know why they wouldn't act covertly when they think it's necessary? I don't know, if they did after the election. After the election, there was certainly a major short squeeze. A big unwind of derivatives when it became obvious that the markets were not going to tank after the election.

I could see market forces that could also lead to that type of a market dislocation in a melt up. But nothing would surprise me at this point. I assume over the years, they have often intervened to stabilize the markets. Because this is a very unstable financial structure.

It's interesting these days. The VIX is so low. Those are the volatility indices that are so low. The assumption is the markets are extremely stable. But, I think the markets are so unstable, the central banks have had to come in with extraordinary markets to convince everyone they're stable; which is part of this misperception that has led to the very dangerous bubble that we see today.

Chris Martenson: You mentioned the things we do know. We do know that the Japanese Central Bank has been buying ETFs of Japanese stock shares and doing it preferentially on days when the markets were declining. That is overt at this point and time. Of course, the Swiss National Bank overtly buying U.S. equities, and particularly the large issues.

That is what we know about. Then, of course, there are things we have to sort of wonder about. Like after Superstorm Sandy as the justification, the New York Fed which has a very large trading desk operation. I would love to see audited just to find out. They said, "Hey, we didn't like how risky it seemed after Sandy proved that things can happen. So, we have decided to move our trading desk somewhere."

Coincidentally, it's in Aurora, Illinois now, which is where for those who know, the Chicago Mercantile Exchange servers are located. Where some of the most highly levered trades exist. That can help do things like drive VIX down or prop, and buy futures in other highly levered products at key moments. If you wanted it to do that. But purely coincidental, we're being led to believe that the Fed moved its trading operation there.

Chris Martenson: As well, we know that the Chicago Mercantile Exchange has a central bank and its preferred buyer program. Because they're such heavy customers. They they've offered them some of the best volume discounts. But Doug, I haven't found a single balance sheet of a single central bank anywhere that will admit to having any of these products anywhere in its portfolio. Yet, they are some of the most heavy buyers.

You call that covert. You call it…. I don't know. It's half over. I don't really know. I am squinting at it. I'm just saying, look, I think these central – and it honestly matter to me. Because I think that they fail. It's just a question of how spectacularly do they fail in these efforts?

What matters to me is that it indicates to me that I think these central banks are actually afraid of the very conditions that they have created for themselves. My overt data for this is by the numbers, and when you look at corporate earnings. When you look at the acceleration in certain things. When you look in certain economic components. When you look at trade.

When you look at growth. Growth isn't great. It's not bad. When you look at unemployment. Listen Doug, by the numbers not bad, but when we wander over and look at the amount of central bank stimulus still pouring into these markets.

Well over one hundred billion a month still, that's an emergency. Which is it? Is everything okay? Or, is it an emergency? I think the central banks are acting like they're scared.

Doug Noland: Right. I agree completely. To me, it gets back. You mentioned it earlier in the conversation. The problem with discretionary monetary management and with discretionary central banking. One mistake leads to a bigger mistake. This is actually a debate that goes back 150 years and back to Britain.

We have seen that repeatedly where we have market distortions that are induced by the central bankers. That lead to a bubble. Then, you have a collapse, and then, only deeper, government involvement. We're at the point now where I think they're very fearful of backing off whatsoever. They talk interest rate normalization. But, we're not even close to that.

The ECB started with their QE program in 2012. Here we are. There is still going to be injecting more liquidity into the markets in 2018, extremely hesitant to back away at all from QE. If everything was stable, I think the central banks would be much more willing to actually move towards normalization.

I don't think for a minute that they believe that finance is stable. I think they know they're dealing with a bubble. I think they're hoping that they can wait. That this inflation dynamic, they can grow their way out of this fragility. But, that's the problem with the bubble.

You can't grow your way out of it. The bubble just gets bigger. They want to inflate this consumer price index to grow our way out of debt and asset price bubbles? Well, all they do is increase the size of the bubble in the asset markets and the underlying distortions in the real economy.

Especially late in the bubble, it's very dangerous. Because the bubbles take on a life of their own. We're seeing it today in bitcoin. We're seeing it in dramatic price moves, and in security. That's fixed income and equity. Their tracked right now. I think that explains a lot of why they've been so hesitant to try to get back to a more normal monetary environment.

Now, they're to the point where I think they just fear doing anything dramatic. At this stage in the bubble, the only way to rein it in is doing something dramatic, and force pain on speculators, and force pain on thos