Month: May 2016

The biggest financial and geopolitical story from mid-April was Saudi Arabia’s threat that should the US pass a bipartisan law which would take away immunity from foreign governments in cases arising from a “terrorist attack that kills an American on American soil” and specifically could hold the Saudi kingdom responsible for its role in the Sept 11, 2001 attacks, then the Saudis would retaliate by selling up to $750 billion in American assets. 

Today, the Saudi foreign minister Adel al-Jubeir, while speaking to reporters in Geneva after talks with U.S. Secretary of State John Kerry which mainly focused on Syria, admitted this threat saying passage of the law would “erode global investor confidence in America” by which he was, of course, referring only to Saudi Arabia. However, to avoid another slap in the face of US foreign policy on the record, he denied that Saudi Arabia had “threatened” to withdraw investment from its close ally and instead called it a mere “warning.”

“We say a law like this would cause an erosion of investor confidence. But then to kind of say, ‘My God the Saudis are threatening us’ – ridiculous,” Jubeir hedged according to Reuters. 

Saudi Foreign Minister Adel al-Jubeir talks to the media in
Geneva, May 2, 2016

“We don’t use monetary policy and we don’t use energy policy and we don’t use economic policy for political purposes. When we invest, we invest as investors. When we sell oil, we sell oil as traders.”

That said we are confident that Jubeir realizes very well that everyone else uses monetary and energy policy for political purposes – hence the Trasury’s brand new Friday watchlist for currency manipulators – which is why when he calls it “erosion of investor confidence” the world reads clearly between the lines.

When he was pressed whether the Saudia Arabia had suggested the law could affect its investment policies, the Saudi foreign minister said: “I say you can warn. What has happened is that people are saying we threatened. We said that a law like this is going to cause investor confidence to shrink. And so not just for Saudi Arabia, but for everybody.“

Ah, so now it is “warn”, not “threaten”… gradually getting warmer. He continued: “In fact what they are doing is stripping the principle of sovereign immunities which would turn the world for international law into the law of the jungle,” Jubeir said.

“That’s why the administration is opposed to it, and that’s why every country in the world is opposed to it.

Well, China not only isn’t opposed to it but China could care less… and China has a little over $1 trillion in US Treasuries. Which implies that all the Saudi was doing was merely trying to avoid a diplomatic threat to its close political ally, one which not even Obama would be able to diffuse.

And then, just to emphasize that Saudi Arabia was not “threatening” the US, he repeated it for the third time: “And then people say ‘Saudi Arabia is threatening the U.S. by pulling our investments’. Nonsense.“

No matter how one calls the Saudi threat or warning or gentle nudge, however, the reality is that it has no chance of passing in Congress. Not only at the bill’s sponsors gradually trying to prevent its passage, but Obama himself has lobbied Congress to block passage of the bill, which passed the Senate Judiciary Committee earlier this year. For those Americans who are confused just whose interests Obama is representing in this matter, those of America’s citizens or Saudi Arabia’s, we have a few words of advice: don’t overthink it.

via http://ift.tt/1QOvm3j Tyler Durden

Authored by David Hay, via EvergreenGavekal.com,

"Low interest rates cause secular stagnation: they do not cure it.” -CHARLES GAVE

 

“Negative interest rates are the dumbest idea ever.” -JEFF GUNDLACH, the new “King of Bonds”

 

“Laugh but listen.” -WINSTON CHURCHILL, addressing the British House of Commons, warning it once again of the rising threat posed by Nazi Germany, to derisive laughter.

SUMMARY

• Overwhelming amounts of government debt are among the “rich” world’s biggest threats. Unfortunately, the political will to cope with this—and the related problem of runaway entitlement spending—is nil.
• Radical monetary measures—such as quantitative easing (QE), plus zero- and negative-interest rate policies (ZIRP and NIRP)—are not stimulating growth. Instead, they are producing stagnation, “lowflation”, deflation, and currency wars.
• However, they have stopped the ticking of the debt bomb. They are also reversing the disadvantaging of younger generations at the expense of the older and wealthier; the latter are the big losers from the eradication of interest rates.
• Investors need to adjust to ZIRP and NIRP. They are likely not going away anytime soon.
• These also make it less probable the US government will resort to high inflation as a form of “stealth default” on its immense debt.
• Central banks printing money to buy government bonds is supposedly the pain-free way to extinguish crushing debt burdens. However, there is no free lunch.
• Monetary authorities are finally realizing QEs, ZIRPs, and NIRPs, are failing to catalyze growth. Discussions about banning high-denomination currency (like $100 bills) are gaining steam as is a debate about the merits of doing “helicopter” money drops (direct money transfers to citizens).
• The Fed suspending its rate normalization scheme (after just one hike!), and the European Central Bank unveiling a raft of extreme easing measures, have triggered rallies in almost everything since early February. Energy, Canadian REITs, and gold mining stocks have been by far the stars.
• US stocks are still trading way above the trend-line growth rate of the economy (GDP). There is always reversion back to that and even below.
• Not trying to be Davey Downer but if things are fine why are QEs, ZIRPs and NIRPs necessary? And why is the US middle class so despondent?
• There are a growing—and disquieting—number of parallels with the 1930s, though, also many differences.
• Some good news: in addition to zero interest rates and tepid growth forestalling the day of debt reckoning, they may be creating a trading range market. Perhaps a vicious bear episode can be avoided, or at least delayed.
• However, investors need to be nimble and contrarian. It’s imperative to overweight those areas—like energy-related last year—where money is fleeing en masse. A passive 60/40, stock/bond, portfolio won’t produce the kind of returns investors desperately need.

The best laid plans…

One of the most pressing questions of our time simply must be: How will the developed world cope with its ever-growing mountain of debt? Despite what some have erroneously called The Great Deleveraging, recent years have seen the global mass of liabilities continue to swell at a rate that puts the continually-erupting Kilauea volcano on Hawaii’s Big Island to shame. If that seems exaggerated, consider that nearly $60 trillion has been added to what was already a towering heap of IOUs since 2007.

Not long ago, fears of this dominated the thinking of policymakers, economists, and even regular mom and pop investors. The existential threat from this debt explosion was admirably addressed several years ago by a bipartisan piece of proposed legislation: Simpson/Bowles. Oh, yeah—remember that blast from the past? The only problem is that it was not just in the past, it also never passed.

But here’s the rub: maybe it didn’t need to be; maybe we’re better off without it. Before long-time EVA readers think I’ve taken leave of what senses I still possess, please allow to me to explain (which is emphatically not to endorse). The period since the Global Financial Crisis—the worst modern economic and market calamity other than the Great Depression—has seen the world’s leading central banks engage in ever-more “creative” strategies to reignite growth and, ironically, inflation. The irony is that for most of their existence, entities like the Fed were continually battling too much inflation, not too little. Further amping up the ironic meter is that trillions and trillions of money fabricated by central banks has created “lowflation” and even deflation.

As many EVA readers know—but few can comprehend—increasingly desperate inspired central bankers have, in recent years, resorted to negative interest rate policies (NIRPs). Ostensibly, these have been implemented to catalyze economic growth. Yet, much like zero interest rate policies (ZIRP) and the now infamous quantitative easings (QEs), the evidence on the ground—as opposed to the academic ivory towers—is that these have almost no positive impact on GDP growth. This is even according to a recent Fed study!

And when it comes to inflation, NIRP, ZIRP and QEs have all been factors in bringing back that dreaded vestige of the 1930s: currency wars. As these competitive currency devaluations have spread around the globe, they have created declining commodity and import prices—at least for those countries that have fallen behind in the debasement cycle.

When this happens, a country (like the US over the last year-and-a-half) begins to run a larger trade deficit. Its companies have a hard time selling their products and services, putting downward pressure on earnings. This typically leads to layoffs and, if severe enough, can cause a recession. You may have noticed (and we’ve tried to help in that regard!) that the US corporate sector is almost certain to have endured three straight quarters of falling profits. Even two in a row is considered an earnings recession.

For awhile, the stock market seemed quite agitated about this outcome. Lately, though, with the Fed at least temporarily halting its official tightening cycle after the heroic move of one lone increase, and the European Central Bank going nuclear on its easing measures, stocks have bounced back close to their highs from last summer. As you may recall, this was right before the August “crashette” that saw the Dow fall 1100 points in less than an hour.

Let’s stop for a moment and recap what these lords of the financial kingdom have wrought…

Paradise (accidentally) found?

Ok, so thus far, ZIRP, NIRP, and “From Here to QE-ternity” monetary policies have given us:

1. The worst economic expansion in modern history.

2. The lowest interest rates since the Middle Ages, if not antiquity.

3. Falling inflation-cum-deflation.

4. Corporations around the world leveraging up to acquire other companies (and, of course, instituting mass layoffs once the deals go through) and buying back their own stock.  These have come at the expense of normal levels of capital spending.

5. Related to 4, and the “cap-ex” plunge, we’ve seen a collapse in productivity which is essential for economic betterment, particularly in aging societies

6. Asset bubbles in everything from collector cars to penny stocks to Manhattan penthouses to, Seattle apartment buildings, to…well, you name it, and the central banks have almost certainly inflated it; many now appear to be leaking oxygen at a steady, if not rapid, rate.

Notice there aren’t any opinions in the foregoing half-dozen points, just observations. You don’t have to have a PhD in economics (in fact, it would probably help if you didn’t!) to realize these ZIRP/NIRP/QE dogs won’t hunt. But, remarkably, this insular group of brainiacs—whom Jim Grant calls the Monetary Mandarins—believe their pack of hounds will pick up the scent real soon—at least by next year. (Have you noticed that the growth break-out is always going to be next year? Don’t worry that we’ve been hearing that for years…and years…and years.)

But let’s give these clever men—and at least one woman–their due. They have come up with an ingenious way to both fund what is an otherwise bankrupting eruption in entitlement spending at the same time that they’ve solved the disadvantaging of younger generations.

Say what?

Did the debt bomb suddenly stop ticking?

As noted at the outset, any attempt to defuse the entitlement time-bomb has been resolutely ignored by our political leaders (cross out hacks). In this regard, they’ve had plenty of company around the world. Yet, my fellow Americans, the ticking is only growing louder, at least from the standpoint of IOUs accumulating at an alarming rate.

Source: Ned Davis Research

However, the aforementioned angst over being buried alive, when the side of the debt mountain finally shears away, was predicated on a belief in the ever-presence of interest rates. As noted in the March 25th EVA, if governments can borrow for free or—even more incredibly—be paid to issue bonds, there are absolutely no worries.

Now, I’m not at all sure the Fed and its global counterparts intended to solve the debt/entitlement crisis but, at least for the time being, they appear to have done so. They’ve also rectified the indenturing of the younger generations. This is because there are always winners and losers from policy prescriptions like NIRP and ZIRP. Young people don’t tend to hold many assets (if they do, these are unlikely to be bonds). They also often have a mortgage to service. Therefore, the extinction of interest rates is manna from heaven. Moreover, the crushing debt burden they were supposed to inherit from the Boomer generation has become as light to bear as a feather on the surface of the moon.

Obviously, there are also losers from such a radical set of policies and it’s manifestly obvious who they are: Nearly anybody with a portfolio, which includes most EVA readers and yours truly. We are the ones who need to make money off money, something NIRPs and ZIRPs render exceedingly difficult.

In recent months, I’ve been discussing negative interest rates with dozens, if not hundreds, of clients and quite a few non-clients (yes, sometimes, I talk even with them!). What I have heard consistently is bewilderment over why anyone would accept a negative return. As also discussed in the March 25th EVA, there are various reasons, including fears of deflation. But, often, it comes down to another acronym, in this case one that has helped prop up the stock market over the last few years: TINA, There Is No Alternative.

Large corporations in Europe, for example, have little choice but to hold their money with a bank or in the short-term bond market. Thus, they accept a slightly negative yield. Longer term yields—out to almost 10 years—are also sub-zero in much of Europe (and in Japan out to 12 years). This is unquestionably a function of the “print-and-buy-bonds” actions of the European Central Bank and the Bank of Japan. Thus, market rates don’t reflect a true cost of capital but rather one fabricated by central banks.

Regardless, it’s the reality we are facing as investors and we’d better adapt to it if we want to produce any kind of positive returns in future years. For sure, someday this nonsensical era will end. Just don’t hold your breath—unless you want to die of asphyxia.

When you come to a fork in the road, take it!

One of Evergreen’s savviest clients and I discussed the end-game possibilities for this surreal scenario a couple of weeks ago. We came to the conclusion, by no means definitive, that things would follow one of two paths: either inflation going bonkers or a semi-perpetual state of economic paralysis such as Japan has known for over 25 years.

When QEs and ZIRPs first made their appearances (and well before NIRPs reared their ugly head), the assumption was that trillions of dollars of fake money would automatically lead to inflation running wild. As noted above, we’ve gotten exactly the opposite. And, as observed in numerous earlier EVAs (though not lately), the reason is the collapse in money velocity. Per the chart below, you can see that the turnover of money is running at 1930s-type levels, one of many current echoes of that turbulent decade.

Source: National Bureau of Economic Research, Federal Reserve, Bawerk.net

Every time a central bank cranks up the printing press, or lowers rates into more negative territory, velocity tumbles yet further. And, as you can see above, there is no sign the trend has bottomed out. It’s possible it will break below the trough seen in the 1930s (the WWII and immediate post-war years were an anomaly due to gearing up, and then down, for the war effort).

The problem is that as velocity craters it sucks the air out of the real economy. Financial assets can flourish, as we’ve seen, at least for awhile. But the cure for high prices is, and always has been, high prices. Stocks, art, and real estate are not exempt from this reality. The huge problem—which investor and central banks are waking up to—is that when gravity bites, there is a spillover impact on economic activity.

Consequently, the monetary powers-that-be feel compelled to keep experimenting with ever more exotic elixirs, designed to perpetuate the artificial high. This channels even greater sums of money into overpriced assets (like buying bonds with negative yields) but does precious little for GDP. Simplistically, but, I think, accurately, trillions are diverted into financial engineering versus real engineering.

The next result in this daisy-chain of reactions is that the economy gets stuck in a state of suspended animation or what some experts have called “secular stagnation”. To combat this, governments are taking the fight to the next level by first declaring war on currency and then threatening to bring in the helicopters.

By the way, we’re not talking about a replay of that classic “Apocalypse Now” Ride of the Valkyries scene. However, it might be just as surreal if it happens.

If at first you don’t succeed…

The first ploy—the war on big bills—centers on trying to abolish “high value” notes like a “Bennie”, the US C-note. Based on how little one of those buys these days, it’s pretty laughable to consider it high-denomination, yet there is a move afoot to call them in, regardless. In Europe, a $500 euro note is in circulation and it is looking very endangered. The official rationale is that these must be eradicated to inhibit tax-dodging and the drug trade. (Are either of those a new phenomenon?) The more sinister—and likely—reason is that killing off big bills will make it harder for people to hoard cash rather than paying their bank to hold deposits. If there were to be a mass shift from deposits to cash, imagine what that would do to money velocity! (Hint, the direction would be decidedly southerly, not northerly.)*

As it becomes increasingly apparent that NIRP/ZIRP and QE are failing, policymakers are also floating the idea of helicopter money. This echoes the long-ago musings of the great Milton Friedman on how to combat depressions (last I looked we were far from that condition, however). Our most recent ex-Fed chairman Ben Bernanke also launched this notion about 15 years ago in a famous speech that earned him the nickname “Helicopter Ben”. The plan would be to once again issue bonds to fund the helicopter drop of cash directly to taxpayers (and many who don’t pay taxes!). This would almost certainly be heavily supported by the aforementioned print-and-buy central bank tactic, with most citizens receiving a check for, say, $2500. The theory is that this will be mostly and almost immediately spent.

It’s possible that such a tactic would work better than the others the central banks have pulled out of their silk top-hats in recent years. But it’s for sure not a surety. They may want to consider what happened in Japan a few years back when that nation issued its citizens spending coupons with an expiration date on them. Regardless of the spend-by-date, the typical recipient still hoarded them! (We’ve seen a whiff of that lately in the US where the windfall from the crash in gasoline prices was supposed to produce a consumer spending surge, but hasn’t.)

Moving beyond the potential ineffectiveness of a helicopter drop, let’s think about this entire monetary “Hail Mary” pass of printing money to buy government bonds. First, central banks today don’t actually print money such as Germany did during the infamous hyper-inflation of the 1920s Weimar Republic (which led to the rise of Adolf Hitler and the incomprehensible nightmare of WWII). Instead, they create reserves, basically digital money that is transferred to the big commercial banks, the dealers in government debt.These banks sell government bonds to the Fed or the ECB and receive the reserves in return (I know, pretty convoluted but we are talking a Federal agency here.)

In normal times—when there is demand for money for things like starting new businesses rather than just playing the financial markets—said reserves can be multiplied 8 to 10 times. This is why they are often referred to as high-powered money. In other words, these reserves are like one of my wife’s adult beverages—they carry a potent kick. But, as noted above, in today’s Twlight Zone economy, they mostly sit idle.

Consequently, there is a belief that this can go on forever. Moreover, some pundits are opining that this amounts to debt cancellation. For example, the Fed has “extinguished” 13% of our national debt, the ECB has theoretically wiped out 16% of its obligations, while the Bank of England has bought back 23% of all UK treasury debt outstanding. Debt-drenched Japan, naturally, is the leader of the pack with a 32% “retirement” of its government liabilities. Some believe all of government debt can be eliminated in this seemingly painless way.

As young folks are given to text these days, OMG! What brilliance! Why did it take them so long to figure this out? If you think there is a catch to this magical solution, you probably also are a believer that socialism works until you run out of other people’s money. In other words, you understand basic economics—unlike, it seems, most of those in the monetary control rooms these days.

The flaw in all of this gets back to the twin dilemma described above: We either see on-going economic flaccidness or those trillions of high-powered money start going viral, as does inflation. In other words, pick your poison.

Come on, Dave, how about accentuating the positive for a change?

Does Debbie Downer have a brother?

You may have noticed that this month’s full-length EVA is a follow-up to the March 25th issue, discussing “The Great Equalizer” of zero and negative interest rates. That edition generated a fair amount of positive response—despite the fact I wrote it. But, as is often the case, there was some “Davey-Downer” feedback.

While it’s certainly true that I think—and have believed for years—the world’s central banks are putting all of us at grave risk, it’s been pretty hard to miss the myriad bullish calls in this newsletter over the past year or so. Admittedly, these have been heavily focused on the smoking ruins of the formerly high-flying energy-related areas. But have you looked at those lately? The S&P 500 has certainly had a great run since early February but that pales by comparison to the rally seen in that timeframe by asset classes such as MLPs (the pipelines), Canadian REITs and gold/gold mining stocks (the latter have been long-time favorites, as well).

For sure, all of these have much further to go to recover from a catastrophic performance in 2015 (and since 2013 for gold). But realize that you can still get 7% to 8% returns on many MLPs and Canadian REITs. Additionally, most of them remain down 40% from their 2014 highs. (By the way, be prepared for a correction after such a dramatic up-move but we believe they have much further to rise over time.)
In other words, Evergreen is willing to be very bullish—and lonely—when valuations are highly attractive. Someday, that will include US stocks. But, for a moment, just slow down and reflect on this chart courtesy of our hard-working and talented Director of Portfolios, Jeff Dicks.

S&P PERFORMANCE AND US GDP GROWTH SINCE 1970

Source: Evergreen Gavekal, Bloomberg

Clearly, the S&P has consistently returned back to the long-term trend of GDP growth and has always gone below it during bear markets (and has often stayed there for years). Ergo, being bullish US stocks, other than on a trading basis, just doesn’t reconcile with the reality displayed above.

Further, if conditions around the world were truly healthy, why would negative interest rates be spreading like rumors about the cause of Prince’s untimely demise? And why have some of the most important banks in the world recently broken below their 2009 end-of-the-world lows?

THREE LEADING BANK STOCK PRICE CHARTS SINCE 2007

Source: Evergreen Gavekal, Bloomberg

If the world’s economies were really out of intensive care, why would ultra-radical monetary policies like helicopter money be increasingly debated at the highest level of governments? Also, how come 70% of Americans believe the US economy is on the wrong course? And why do almost half of US citizens admit they couldn’t come up with $400 to meet an unexpected need? Yes, I know why ask why? And it is what is, and a bunch of other clichés. But this isn’t normal, it isn’t healthy, and—at least in the opinion of this author—it isn’t going to end well.

Rising above human nature.

This week I’ve been viewing a TV series on AHC (American Heroes Channel) dedicated to the rise of Fascism during the 1930s. Frankly, it broke my heart. The loss of human life and the brutality of the demagogues of that decade were almost unbearable to watch.

Past EVAs and other sources, such as celebrated demographer Neil Howe, have pointed out the numerous parallels with present times and the decade of the Great Depression. Obviously, there are many, many differences but the growing similarities are becoming disquieting in the extreme. These include but are not limited to: rising nationalism, growing protectionism, currency wars, the ascendancy of far-right and hard-left political candidates, eroding faith in key institutions, an isolationist US, chronic over-capacity in numerous industries, and a host of other similarities.

But let’s end on a positive note, even of a qualified nature. Everyone with a healthy dose of rationality realized long ago that not all the debt countries like the US have accumulated can be serviced, much less repaid. This inability would be dramatically worsened in the event interest rates “normalize”. Therefore, some kind of restructuring—aka, default—was always in the cards, barring the type of sweeping entitlement reforms, like Simpson-Bowles, for which there appears to be almost zero political appetite.

For a country like America, with the good fortune to be able to repay its liabilities in its own currency, the de facto default scenario was likely to be using inflation to gradually erode the value of the indebtedness. In other words, there would be a kind of stealth shafting of creditors. Even the 2%-type inflation the US has experienced for years is a form of this, though it has been a very slow bleed.

Now, however, there is an alternative path. Instead of lowering the total debt outstanding through high inflation, we have witnessed a huge reduction in the interest rate on these liabilities. As long as rates stay near zero, there is no need to resort to inflation. But it does create a situation where governments have a perverse incentive to keep growth slow and interest rates suppressed. As years of deficient economic activity have demonstrated (case in point: today’s pathetic GDP report), present policies seem to be doing a superb job of exactly that!

Japan has shown that a rich country can limp along for decades and keep piling up the national debt as long as rates stay close to zero. (Now that they’ve gone below zero, the sky’s the limit!) Evergreen has asserted for many years that we need to be on alert for the Japanization of America in terms of what were once unthinkably low rates. As noted earlier in this letter, the European Union is well ahead of us in that regard.

On another semi-upbeat note, perhaps this tepid condition—with central banks constantly holding down interest rates and propping up asset prices—can keep the stock market in a long-term trading range versus a painful, but cathartic, bear market. By definition, though, it’s hard to make money in a sideways market, unless you are nimble enough to sell into rallies and buy into pull-backs.

The implication for investors from all of this is just how challenging it will be to produce adequate cash flow and/or returns. But as we saw last year for all things energy-related, there will be opportunities to do so when money is rapidly fleeing from certain market sectors and/or asset classes. A passive 60% stocks/40% bonds portfolio just isn’t going to cut it.

There’s rarely been a time when following a contrarian approach has been so essential. The trouble with being a contrarian is that it’s just so darn contrary to human nature. But as Katherine Hepburn told Humphrey Bogart in The African Queen, human nature is what we are put in this world to rise above.

*Trying to eliminate the $500 euro might be quite a battle in Deutschland.  As my buddy, Grant Williams, points out, 84% of transactions in Germany in 2014 were in cash.  There must be a lot of German drug dealers and tax-cheats!

via http://ift.tt/1SHlq1b Tyler Durden

Sadly, a typical consequence of war is that innocent “collateral damage” lives are lost. The civil war in Syria is no different, as over the past week four medical facilities were hit with missiles from fighter jets taking out their targets from the skies, pushing the civilian death toll even higher.

One of the targets that got hit last week (during a truce nonetheless) was a pediatric hospital in Aleppo that was supported by both Doctors Without Borders and the International Red Cross. Recovered cctv footage captures the moments before, during, and after the hospital took a direct hit.

The video also shows what is said to the be the last pediatrician in the city walking the halls moments before the missile hit, killing him and an estimated 50 others.

U.S. Secretary of State John Kerry condemned the attack, immediately blaming the Syrian government. Predictably everyone involved in the region has denied having anything to do with the strike.

“We are outraged by yesterday’s airstrikes in Aleppo on the al Quds hospital supported by both Doctors Without Borders and the International Committee of the Red Cross, which killed dozens of people, including children, patients and medical personnel,” he said in a statement.

 

“It appears to have been a deliberate strike on a known medical facility and follows the Assad regime’s appalling record of striking such facilities and first responders. These strikes have killed hundreds of innocent Syrians.”

As a reminder, the U.S. isn’t innocent of horrendous events such as this, as just last October the U.S. repeatedly bombed a compound run by the humanitarian organization Doctors Without Borders, killing at least 30 people.

Here is the raw footage of the bombing last week via ABC news. In the final seconds of the video, a person emerges carrying what appears to be a baby, driving home the realities of what can happen when nations meddle in others affairs.

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Submitted by John Mauldin via MauldinEconomics.com,

The world is undergoing a profound demographic shift that will cause sweeping changes over the next few decades. 

Those changes will broaden the scope of our study of economics and investing; they will alter our understanding of sociology; and they will radically affect politics and governments.

Precisely what these changes will be is difficult to discern and predicting them requires some guesswork, but the one thing we don’t have to guess about is the demographic shift itself. 

Now, let’s begin with the big picture.

The world’s population could reach 14 billion by 2100

Experts think human population could fall to 6 billion or hit 14 billion until the end of this century. The gap is that wide because demographic projections require many assumptions. Small changes can combine to make a dramatic difference over time.

Uncertain future events could also bend the population curve. Baby booms and busts, wars, famines, epidemics, medical breakthroughs, and more are all potential game-changers. 

The late 20th century acceleration in population growth was mainly a result of modern vaccinations. Other technologies could have—and I think will have—similar impacts in the future.

Technology can cut the other way, too. We now have the capacity to wipe out entire nations with nuclear weapons. Some scientists think our excessive antibiotic use will create drug-resistant superbugs that could kill millions. I don’t expect such events, but we can’t rule them out, either.

For now, we are at least reproducing faster than we are dying. The result is a growing global population, which masks another problem.

Populations are shrinking in much of the developed world

If the global population is on the rise, it doesn’t mean it’s growing at the same rate in every country, or even growing at all.

We find the highest growth rates, for example, in sub-Saharan Africa and parts of the Middle East. The lowest growth is in Eastern Europe, Russia, China, and Japan. 

Notice the countries shown in shades of blue below. They are actually shrinking in population.

If you want your nation’s population to grow, you need a higher fertility rate and/or longer life expectancy. Africa has both factors on its side, though fertility rates are beginning to decline there, too.

Lifespans are growing almost everywhere

Falling fertility rates and longer lifespans mean that the global population is getting older. This will bring something remarkable in the next few years: the world will soon have more people over age 65 than it has children under 5.

 
Source: An Aging World: 2015

You can see in the chart that the elderly population is growing much faster than the child population is shrinking. As our ability to extend lifespans grows, the disparity between these populations will get worse.

Who will support children and the elderly?

The aging population dynamic means we will have fewer younger people supporting a larger number of older people. Don’t forget that children need care, too. So the real problem will be lack of middle-aged people to support both children and the elderly.

Here is another chart from the “Aging World” report:

Source: An Aging World: 2015

For every 100 working-age (20-64) people, there will be almost 80 children and retirees who will require support by 2050. That sounds bad, but notice how little the ratio actually changes from now until then.

The global data, however, doesn’t reveal the real scale of this issue because we haven’t arranged ourselves on the planet in neat, homogeneous groups. 

In fact, most of the children are going to be in Africa and the arc around the Indian Ocean, while most of the retirees will cluster in the developed world and China.

The demographic crisis will hit China first

China’s one-child policy has created an ugly, upside-down pyramid. Each worker in that generation could end up supporting two parents, four grandparents, and perhaps one or more children, too. 

The demographic reality is that the working-age Chinese population almost literally falls off a cliff starting in the next few years.

Here’s a chart that shows working-age numbers in China…

… and another chart showing China as compared to the US, Japan, Ireland, and Spain. 

Notice that China still has a higher percentage of working-age people than the other countries do, but these other countries grew relatively rich before they growing old. China does not have a Social Security program or anything like the safety nets common in the developed world. 

None of this is good news for either China or the rest of the world. The aging of the world’s population is becoming a vast global issue that will affect multiple domains and shape the world in the coming decades. It is already having profound effects on the global economy, and it’s just getting started…

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When we last looked at the soaring default rate among junk bonds issuers just two weeks ago, we noted that the $14 billion in defaults had already pushed the April total to the highest since 2014, while the first quarter was the fifth highest quarterly default total on record.

But it was the stark deterioration within the energy space that we said would promptly push high yield bond defaults within the troubled sector to hit all time highs in very short notice.

That prediction was validated less than a month later because following this weekend’s bankruptcies of Ultra Petroleum and Midstate Petroleum which added $3.1 billion to the mushrooming high-yield energy bond default volume tally, in addition to the $1.5 billion of credit facility defaults, the energy high-yield default has soared to a record 13% rate, surpassing the 9.7% mark set in 1999, according to Fitch Ratings.

To be sure, neither of these defaults were a surprise: prior to this weekend, Fitch had a 2016 energy sector default forecast of 20% and included both of these filings in the annual forecast. Furthermore, based on the current bond trading prices of approximately $0.15 for Ultra’s $850 million 6.125% bonds due 2024 and $450 million 5.75% bonds due 2018, the market also expects well below-average bond recoveries, something else we have previously highlighted will be a distinct feature of this default cycle.

 

As Fitch goes on to note, Ultra Petroleum cited persistently low natural gas pricing that left it with an unsustainable capital structure as reason for filing. The company plans to use the bankruptcy process to renegotiate unprofitable contracts as well as reduce its $3.7 billion of total bank and bond debt obligations. The $999 million reserve-based credit facility (RBL) at subsidiary borrower Ultra Resources was essentially fully drawn at the time of filing, following a $216 million draw in February 2016.

Ultra’s bankruptcy was expected as it followed the expiration of grace periods for interest payments on notes, nonpayment of certain pipeline transportation fees, bank covenant violations and de-listing of the common shares.

Midstates Petroleum’s filing affects approximately $1.8 billion of total debt and is based on a pre-arranged plan support agreement with its lenders under the reserve-based revolving credit facility that represents approximately 80% of first lien facility borrowings, along with certain other creditors holding approximately 74% of second lien debt and 77% in principal amount of the third lien debt. The proposed plan incorporates some secured debt paydowns and equity conversion of debt that is junior to the first lien debt. Low commodity prices triggered a liquidity crunch at the company.

Low market trading prices on the bonds portend poor recoveries for unsecured creditors. Midstates’s unsecured $294 million, 10.75% senior unsecured bonds, due 2020, and $348 million, 9.25% senior unsecured bonds, due 2021, were bid at $1.875 and $1.75, respectively. The $625 million, 10% second lien notes, due 2020, were bid at $44.625 and the $524 million, 12% third lien notes, due 2020, were bid at eight cents on the dollar.

In more bad news for bank lenders, Midstates, like Ultra borrowed up to the remaining maximum RBL borrowing base in the months leading up to bankruptcy. Midstates drew $249 million under its $750 million RBL in February 2016 to build cash in advance of the bankruptcy filing and the April 2016 re-determination. Full draws of RBLs ahead of restructuring and re-determinations have occurred among some of the most distressed E&P companies as they plan to enter restructuring with this cash liquidity. Linn Energy and W&T Offshore are two other E&P companies that recently fully utilized RBLs.

But this biggest problem for banks is that as more energy companies default should oil prices fail to materially recover, leading to tumbling recoveries across the capital structure and far greater impairments than modeled, the question will once again become one of just who has the greatest committed exposure to the energy sector, especially if as we hinted earlier today, the oil price pattern from last summer reasserts itself and WTI proceeds to slide once more as shale producers resume pumping now that they have been properly hedged following the recent rebound in oil.

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