Must Read: UBS' Andy Lees On Why The US Economy Is, All Else Equal, Doomed

Tyler Durden's picture

"With all the mess going on at the moment, I thought it was worth while stepping back a little and trying to look at the bigger picture." So begins Andy Lees' latest must read letter to clients whch explains succinctly virtually the entire story of where we were, how we got to where are now, how the current trajectory is unsustainable, why due to decades of capital misallocation anything that the Fed does now is essentially irrelevant, why our untenable debt pile does nothing but perpetuate an unsustainable ponzi scheme which will result in an unseen explosion in the true cost of capital: gold, and why the bond market will eventually, and inevitably, force an epic repricing in the cost of non-gold capital absent the arrival of the deux ex machina of real, actionable innovation that the Fed, and all global central planners, keep hoping for. Because the longer we keep plugging away with that worthless substitute, financial innovation, which is anything but, the greater the final collapse. Andy's conclusion: "Until the debt is cleared and capital starts to be properly allocated, economic growth per unit of additional debt will continue to sour. Until we get some real breakthrough technology, requiring large amounts of capital to both innovate and then roll out, we have no chance of supporting the economy." Too bad than that this absolutely spot on observation reflects precisely the opposite of what the Fed is pursuing. Which is why, all else equal, and it will be unless the Fed is finally eliminated from existence, America, and the entire western way of life, is doomed... But don't take our word for it. Here is Andy.

Why are we here: simple - years of central planning resulting in the greatest experiment in capital misallocation in history.

We are in this mess because of excessive leverage and excessive consumption, financed by excessively cheap real capital – (not just Bernanke & Greenspan but further back to the end of the gold standard, and in fact even before that as it was this misallocation of capital that forced us off the gold standard in the first place). If capital had been allocated productively, then by definition debt would fall as a percentage of GDP. Total debt may rise, but efficient allocation of capital would always mean the economy would grow faster than the debt as it means you are making a positive rather than negative real return on that capital.


Whichever way you look at it, capital has been massively misallocated for years.

Corporate profits... or massive debt-funded ponzi scheme?

How can that be when corporates report massive profits? The profits are based on paying their workers a salary that meant they could only buy the goods they made by borrowing; in other words, a massive unsustainable ponzi scheme that could only ever end up with default.  Without the household debt accumulation, there would be no market to sell their products to, and without paying the workers sufficient, the debt would always have to default.


This required a massive increase in financial innovation to keep the illusion of corporate profitability alive – (household debt was a way of delaying putting the true costs through the corporate P&L account and recognising the costs). Financial sector innovation is itself another form of capital misallocation, taxing people away from real innovation – (to keep the illusion alive, an ever greater percentage of economic output had to be allocated to this illusion machine) - helping add to the resource constraint we are in today.

If financial innovation, which we have so much of is not needed, what is the right kind? And why is it so sorely missing.

A lot of what are described as efficiency gains have been just the removal of levels of safety and the removal of innovation in the system. Innovation and ongoing operations are always and inevitably in conflict, with the most readily apparent conflict between short and long term priorities. A second handicap to innovation is the way efficiency is achieved by breaking down things into small repeatable tasks. This specialisation and repeatability is a company’s greatest strength, but it is also its greatest weakness. Innovation is neither repeatable nor predictable. It is non-routine and uncertain. (Book: The Other Side of Innovation).

The culprit: none other than the great moderation, and, now, ZIRP4EVA:

Low real interest rates support excessive consumption, taking money away from innovation and balance sheets. When the US started suffering from its peak oil in 1970, rather than innovation it turned to globalisation to tax the broader global resource balance sheet, just as Britain and Europe had done 100 years earlier through colonialism, and recently accelerated that with the WTO. Globalisation has always been about accessing resources.

Which bring us to topic #1 here, and everywhere else where economics is involved: cash flows.

This has been a factor mobilisation story on unprecedented proportions, but appears to have reached its conclusion as resource constraint has meant the “cash flow” to grease the wheels has started to become more expensive and constrained. Profit without productivity can only carry on for a finite period; we are now clearly consuming down our balance sheet or putting it through the P&L account.


So we are left with a massive amount of debt, a massive amount of capital and labour that is unprofitable in the world we face, and a balance sheet of insufficient resources to keep the illusion alive. The only thing that will get us out of this in the long run is innovation which will expand the balance sheet, expand the pie and create the jobs that people want.


How do we get rid of the debt? Are we in a debt trap whereby any interest rate hike will kill the recovery? Clearly it is going to be incredibly difficult, but low real rates are the cause of the problem, not the solution. I don’t personally see a  zero rate trap, but we need to allocate capital far more productively than we are doing.

The cost of money itself is hugely important. How negative were real rates? When people talk of borrowing from the future, surely the same logic applies to the cost of capital. If we have had low or negative rates that supported excessive consumption, we now need to have high real rates to direct capital back to innovation and gradually repair the balance sheet. The real cost of capital has to go up. No matter how much fighting the Fed and Treasury do, the real cost of capital will rise. The bond markets have to be allowed to clear some of the debt and thereby remove some of this misallocation of capital.

It's not "debt trap", it is "Fed trap"

Does that mean we are trapped in a position whereby the Fed cannot raise rates? Quite frankly it doesn’t really matter what the Fed does; real rates have to go up, are going up and will go up. The more the Fed and the government misallocate capital, the more the real cost of capital will have to rise higher to compensate. The only thing that will get real rates down is either a massive new discovery of incredibly cheap fossil fuels or the innovation that delivers cheap fusion. Otherwise it is a case of the cost of capital rising and causing demand destruction. 


Getting the central banks monetary policy inline with the real cost of capital in the market must be the first step to rectifying the misallocation of capital. One obvious thing would be for economists to stop ignoring CPI of food and energy as irrelevant as it is the fastest growing part of the economy. By ignoring it, they are turning what should be a smooth and relatively painless transfer of capital into an occasional out-of control collapse and transfer. Getting both a proper monetary and fiscal policy framework in place, based off genuine data rather than smoke and mirrors and fiddles must be the first priority. 

Which brings us to where we are now: a massive, unsustainable ponzi scheme:

Whilst politicians and investors acknowledge that excessive leverage created the asset and debt bubble, they do everything they can to prevent a rational deleveraging or efficient allocation of capital. For the moment the best measure of the cost of capital is gold. For years gold fell as fiat money was printed and this unsustainable ponzi scheme established, however as that ponzi scheme now unravels, gold must go up. The scale of both the ponzi scheme collapse and gold appreciation will be huge.


The problem is total credit market debt is still increasing. 


As Fitch recently highlighted, Chinese on & off balance sheet debt has expanded by nearly 40% GDP in each of the last 3 years. In other words, the misallocation of capital is continuing making the ultimate problem that much worse. China is now getting almost no growth per unit of additional debt. 


With each additional unit of debt, we are digging ourselves a deeper hole to get ourselves out of. Surely it is better to at least slow the digging? If we can allocate capital productively at the margin – (we know where we need to start making real returns) – then once we can start making a positive return on that marginal debt, then it becomes easier to support the residual debt we have.

If Andy is right, the framework of the next great class class conflict is set: it will be between the productive private economy and the "unproductive economy." Yes: Marxist tensions are about to make a repeat appearance:

Private sector annuity rates will be tumbling and yet the unproductive public sector are still being given great pensions. We are taxing the productive private economy to give to the unproductive economy. This has to end. The idea of a European fiscal union fills me with dread as that would be locking this unproductive transfer into stone. Rather than keep kicking the can down the road, lets own up to our excesses and start putting the economy back on track. Don’t reward the rioters in London with yet another handout; force them to pay for the damage they have caused and the police time they have consumed.

Is Greenspan to blame for this dead end? Yes... but only so far. One can just as readily blame the traditional duel between short and long-termism, or what is known better as "it will be the other administration's/generation's issue." In other words, Washington is just as guilty as Wall Street, and that infamous private bank.

Why have we misallocated capital for so long? We can blame it on democracy, but bigger than democracy is the culture that forces politicians to favour the immediate status quo over the longer term good of the country. That culture then presumably comes down to poor understanding which comes back to low levels of education. We need to address these route courses.

His conclusion:

The real cost of capital has to rise. That will happen through default in one way or another. Debt has to be cleared. Multiple contraction is inevitable.


Financial sector innovation has to be squeezed by engineering and scientific innovation. Until the debt is cleared and capital starts to be properly allocated, economic growth per unit of additional debt will continue to sour.


Energy is the cash flow in this story. Until we get some real breakthrough technology, requiring large amounts of capital to both innovate and then roll out, we have no chance of supporting the economy.

Nothing can be added to this.

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Bolweevil's picture

I disagree, somewhat. A certain blogger whose name I won't mention took it upon himself to enlighten the masses with straight dope, that wasn't dumbed-down because he thought they could not only take it they might enjoy it. His blog has become wildly popular amongst those in the know. Perhaps you could rephrase your nearly accurate acronym with a "most" or "a majority" since we're tossing generalizations about?

rambo1028's picture

Exactly! So many of them absolutely do not believe, not only that the system is failing, but they don't even believe that it is possible for it to fail. HELLO!!! it's right in front of your face!! How long can or will they keep their heads buried in the sand? I seriously think they aren't going to give a shit until they are being herded into the trucks headed for the camps. And even then, they won't protest. They will just be confused...

Snidley Whipsnae's picture

First the gov will let people go hungry and cold for a few days... Then the promise of 'lots of food and a warm place to live if you board this truck bound for the camps' will work well...

The Rise and Fall of the Third Reich

SheHunter's picture

Don't be so certain all are clicking away  Andy-B.  Quite a few Wisconsin-ites are awake this eve and cheering the underdog Dems as they try and regain a voice.

CompassionateFascist's picture

You stupid, lying, corrupt fuckhead. Wisc. "public employees" are the lower echelon of the dictatorship of the bureaucracy, being paid with  $$ stolen from productive people via taxes and debt. They get vote for the Democraps., ie, more of the same in a cycle that eventually eats away the entire free market and replaces it with state socialism. Some time before then, tho, we go to the gun. Bullets, not bought-and-paid-for ballots,  RedScum.

smore's picture

You obviously missed this in the article, She-Hunter:


"We are taxing the productive private economy to give to the unproductive economy. This has to end."





Havana White's picture

Yep.  QE as Fed policy "endorsement."  Because changing "extended" to "2013" does not a rally make.  The announcement was greeted by a 200 pt Dow drop.  It suddenly turned up, on a dime.  Suspicious..

Meanwhile, this tweaking of economic reports, only to revise them when they're old news, is eventually going to lead to having to do instant revision estimates, if this bullshit continues.  You've gotta ask why nearly all of these revisions are in the same direction -- worse than originally reported.

Down, after the dust resettles.

Snidley Whipsnae's picture

Havana... Didn't you watch the instant revision of the Feds comments today? Fed said no QE, equities began a sell off, Goldman Sucks revised the Feds comments to 'QE 3 now' and markets rallied ~400 points.

So what the Fed said was dumped in favor of what GS said... and the stampede of the fools into equities was on...

So the Fed avoided more scrutiny by the ratings agencies as GS called QE3 for them. The had their cake and ate it too...

What a bloody mess

Pain Train's picture

Slightly off topic, but do yourself a favor and watch Ratigan here. I promise it'll be worth 8 mins of your time:

owensdrillin's picture

Hard to believe that someone from MSNBC could say bad things about the beloved leader, I'm pretty sure Dylan will be looking for a job tomorrow.

ratso's picture

All that to say buy gold blah blah ..

ratso's picture

Oh yeah, I forgot.  The article is crap.

High Plains Drifter's picture

I agree. what good does it do any of us to read such rubbish?

Dick Fitz's picture

Wow, I wish there was a junk-1000 for HPD and ratso. The fact that you can't comprehend the simple yet profound truth of this article just shows how your reasoning skills have degenerated due to gubmint skoolin.

High Plains Drifter's picture

a thousand junks. wow, you are so kind . i guess they can call you dick for short but not for long, ..........

lawrence1's picture

Nothing, but I seriously doubt, considering many of your other comments, that you are capable of understanding it.

smore's picture

HPD, if you can't understand the articles here, please just take your gun and go to a site where the material suits your reading level.

sgt_doom's picture

Exactly, my dear ratso, exactly!

The crap writer claims "..We are in this mess because of excessive leverage and excessive consumption,..."

Exxxxcuuuuse me, dood crap article writer, but excessive leverage directly and primarily profited the banksters and those securities dealers and their skanky whores.

They sold from $900 TRILLION to $1.2 QUADRILLION dollars worth of credit derivatives --- which they claimed were worth something on Monday, but turned out to be worthless by Friday!!!

So why haven't they returned all those billions and trillions of dollars of ill-gotten gains???


And that's why the banksters want austerity throughout Europe and the USA, and that's why healthcare costs so damn much in the USA (as of 2007, 90 dedicated healthcare hedge funds were speculating on the entirety of the US healthcare sector, and from 2001 to 2009 there were billions in private equity leveraged buyouts --- from structured finance deals with the banksters based upon leveraged securitized credit derivatives. 

According to a recent Commodity Futures Trading Commission study, 95% --- THAT'S 95 FRIGGING PERCENT --- of commodity trades are speculation.  So much for all that hedging bulls**t --- the ISDA claims that credit default swaps don't figure in because of all the bonds out there --- but it only takes a limited number of naked swaps targeting specific trading to dramatically alter everything!

Do you copy???

andybev01's picture

I head the number as 4 quadrillion.

I guess a quadrillion just isn't what it used to be.

Snidley Whipsnae's picture

The whole damn planet probably don't have 4 quadrillion grains of dirt in it...

anarkst's picture

"Nothing can be added to this."


wisefool's picture


Energy is the cash flow in this story. Until we get some real breakthrough technology, requiring large amounts of capital to both innovate and then roll out, we have no chance of supporting the economy.

Some of the most brilliant people in the world work for General Electric, tax avoidance division.

Go Immelt, help us discover the wonders of Planet O!

Tuco Benedicto Pacifico Juan Maria Ramirez's picture

No one works in the GE tax avoidance division.  They don't have to since GE is part of the corporate fascits state that has hijacked our government!    They don't bend the rules.  They make them!


mind_imminst's picture

Nice sarcasm, lol. The author does bring up a good point though, about innovation and progress. Even though the macro environment is terrible, there are still companies innovating out there. Worker productivity continues to rise. GDP per energy unit keeps getting better every year. These things are happening in spite of the terrible business environment in the U.S. right now. The debt and ponzi scheme has gotten waaaaaaaay ahead of technological progress and efficiency gains IMO, but don't forget that progress continues. I think that puts a floor on how low asset prices can go.

smore's picture

The sad thing is that no "breakthrough technology" is needed, it's right in front of our faces: ethanol. No, not corn ethanol, ethanol.  I'll post this again:


The following is a review of David Blume's book Alcohol Can Be a Gas; all figures and statistics come directly from Mr. Blume's book.   David Blume, an organic farmer and leader of the alcohol revolution, provides evidence that ethanol alcohol is a viable and renewable fuel source that can help to remove dependence on foreign oil and bring jobs back to America.     Imagine the US as an independent self-sufficient nation with a production economy once again!   Many people have concerns about food shortages because crops are grown for fuel instead of food. One of the greatest misconceptions about alcohol is that it will use up land that could be used to grow food.  This belief is based on the use of corn to produce ethanol, which is very inefficient.  According to Blume, there are other crops that can produce 3 times as much ethanol and those crops need not be grown on prime cropland, but can be grown on farmland that is not as level and has more shallow soil.  Most of this farmland is arid and mesquite trees could passively grow there.  Blume says, "mesquite harvested seedpods would generate 33 billion gallons of alcohol, without irrigation, fertilization or annual planting.  That is another 21% of our annual gasoline needs from only 7.45% of our farmland."

Lowlands, swamps and wetlands can be used to cultivate high yielding plants like cattails, whicn are considered a weed.  Blume says that cattails can be used inexpensively to treat sewage and that the "yields of starch and cellulose from cattails can easily top 10,000 gallons per acre.  If all the sewage in the US were sent to constructed marshes, the 3141 counties would need only 6360 acres each to fulfill all of our foreseeable transportation fuel needs, both gasoline and diesel, at 200 billion gallons per year.  This equals 1.4% of our agricultural land".  No irrigation or chemical fertilizers would be needed.  Additionally, they provide a profitable way to clean up rivers, streams and oceans by detoxifying chemicals and removing heavy metals like mercury which is evaporated out through the leaves.

  Blume says that cellulose can be used as a fuel source and that the US has 30 million acres of lawn (this is about 40% of the total acreage used for corn), and it isn't counted as cropland or farmland.  Grass clippings alone could generate over 11 billion gallons of fuel per year.  This doesn't even include green waste from landscaping that could be added to the cellulose totals in each county.   Ethanol can also be extracted from the ocean while cleaning it!  Dead zones are areas near coastlines with decreased concentrations of sea life due to elevated levels of nitrogen, usually caused by chemical fertilizer and industrial waste.  The nitrogen causes a population boom in microscopic algae and then it decomposes.  During algae decomposition, the oxygen in the water is consumed and kills off the concentrated sea life.  There is almost 8000 square miles of dead zone in the Gulf of Mexico and dead zones also exist along the Oregon, Washington, California and and Eastern Sea coasts.  Kelp is made up of brown algae; in China and Norway this kelp is dried to produce fertilizer.  Blume recommends that the US adopt this strategy to eliminate the need for polluting chemical and petroleum fertilizers.  He further advocates fermenting the kelp first to make alcohol and then fermenting the leftover mash a second time for methane.  The California coast alone could yield almost 90 billion gallons of fuel.  The remaining 2/3 of the energy as methane would provide all the alcohol plant process energy plus a huge surplus of gas/electricity for business and residential use. Combined with the other dead zones, all transportation fuel as well as the majority of natural gas could be replaced without using a square foot of farmland.   Blume says that the top four US crops are rice, wheat, corn and potatoes which are 75% starch and he suggests that malnutrition is a protein deficiency as opposed to a caloric deficiency.  He advocates increasing protein production by cultivating oyster mushrooms that can be grown using just 25% of the grain straw that is annually burned off of fields as the fungi can efficiently extract the protein from the straw.  Blume writes, "So if we really wanted to feed everyone, even without using a single animal as a food source, it would not be difficult".   The US uses 87% of its corn crop as animal feed; when alcohol is made from the corn, which removes the starch, the protein, fat, some of the cellulose, vitamins and minerals along with the yeast from fermentation remains.  The remaining substance is called distiller's dried grains with solubles (DDGS) and is about one third of the volume of the original corn after the starch is removed.  DDGS is a far superior animal feed that eliminates huge health problems in cattle because they cannot digest the starch in corn.  Of course Blume, as an organic farmer, shuns GMO products.   Blume tells a fascinating story about his organic farm with less than 2 acres of uneven land in San Francisco that produced enough food to feed as many as 450 people.  He converted the organic content of the soil from 2% to 22% and the adobe clay soil was transformed from 1 inch of topsoil to 16 inches of topsoil.  His little patch of land produced over 100,000 pounds of food per acre.     Blume's book covers how to convert your car to run on alcohol.  If you have a flex fuel car, you're good to go.  You can also purchase a conversion kit from his website for $400 to $700 (depending on the size of your engine).  The kits are made in the US and allow you to burn straight gasoline, E85 or 100% ethanol.  Alcohol fuel conversion kits have been used successfully in Brazil on over 50,000 cars over the last 20 years with no reports of of engine damage resulting from the kits or running on ethanol.   Small 2 stroke engine problems are preventable by using a lubricant and the proper grade of alcohol.    Rockefeller foisted 'prohibition' on the US in order to create a fuel monopoly with gasoline; Ford's Model T originally ran on alcohol that people could grow and distill themselves.     America is abundant and is still full of opportunity!  We must think for ourselves and stop allowing big corporations tell us that the only source of energy is from that which they derive a profit.  If we work with nature, we could feed and fuel the world in addition to massively reducing pollution.   David Blume's book, Alcohol Can Be A Gas, may be purchased from his website which contains a wealth of information. 
Dick Fitz's picture

You're right- it lays out, in simple terms, the problem and solution to our current fiscal cancer.

High Plains Drifter's picture

sure it does pal. just keep telling yourself that. 

Critical Path's picture

Was just watching Sir James Goldsmiths interview with Charlie Rose regarding the efficiency we call labor arbitrage... er GATT.

Glad to see someone had it right almost 2 decades ago...

How about we undo this bullshit.

Irish66's picture

The tide is finally turning.  Some peoplel are actually trying to tell the truth.

High Plains Drifter's picture

ok, tell me what truth did he tell me, so that i may know the truth..........

anynonmous's picture

Just got back from the eye doc so the reading is limited for a couple more housr


WTF happened I see a cliff dive followed by Mt Everest


Tuco Benedicto Pacifico Juan Maria Ramirez's picture

The free market at work...cough, cough.



PaperBugsBurn's picture






Bam_Man's picture

Why have we misallocated capital for so long?

Because we could, that's why.

Truly an "Exorbitant Privilege", bitchezzzz!

economessed's picture

That, and we designed our entire educational system around the concept of extracting value from the economy rather than adding value to it.

Bob's picture

Certainly true for the white collar class, at least. 

Kat's picture

Why innovate when the Wrecking Ball in Chief has made it clear he will fight to the death to confiscate your wealth if you're successful?  Either he'll use the IRS or the Fed to wrench it from you. 

Don't take risks and don't bother being productive (unless you're working on your subsistence garden).

cossack55's picture

Go Galt on their ass, baby.

Kat's picture

Ya know....funny you should mention that because I was talking to a buddy of mine who is telling me that's exactly what a lot of people are doing.  They're still physically at work, but they put in a minimal effort and take no risks.  They know they won't be paid if it works out and if they lose ont he bet, they'll get fired.  That's a trader's life at a Too Big to Fail these days.

Everybody else is just not expanding into new busineses because they just can't figure out what the cost of the plethora of new idiot regulations will be. 

More people have "gone galt" than one would imagine.

High Plains Drifter's picture

heck when i was younger, i used to do that all the time. what is so special about that. it is something you learn how to do. it is called personal survival.  their job is to get as much out of you as they possibly can. your job is to try and do the least amount of work you possibly can and then make it look like you have been working. no big deal. that is real life here in the slave galleys of amerika.  be happy in your work............

Kat's picture

That difference in attitude probably explains why I'm so much more successful than you are.

High Plains Drifter's picture

oh come on now.  look its simple. can you fall asleep at your desk and make it look like you are reading?  can you tell when your boss is coming by the way his shoes impact the floor? gads man. wake up.....

TwelfthVulture's picture

People who go Galt are their own bosses, they would never work for someone else.  Or, to put it another way, the fact that you work for someone else means you are not John Galt.

Havana White's picture

Have some more GOP Kool-Aid, Kat.  Mmm, regulations gotta go, gulp, gulp, gulp.

karzai_luver's picture

whahaaaaaaaaaaaaaa whaaaaaaaaaaaaaaa whhaaaaaaaaaaaaaaaaaaa


You fukin pussy, why don't you and a dozen of your TBTF trader scum leap from the highest ledge or just gas yourself if no high point is available.


I will luv it when they hang you fukin kiddies right along with blankfuck and DIMon.


O happy day.


Kat's picture

So, basically, you're just advertising that you're a bloodthirsty moron.  Good to know.

Seer's picture

"Everybody else is just not expanding into new busineses because they just can't figure out what the cost of the plethora of new idiot regulations will be."

This is WAY overblown (fits the story of "anyone can get rich, so please don't beat up on the rich").  Innovators will innovate, you cannot stop them.  What is being hampered is R&D at BIG corporations, or so they want us to believe- folks here are wanting to establish new loopholes and tax breaks, THAT's why things are/have been stalling out.  These folks have little in the way of innovation, requiring a LOT of sales of crap in order to keep the innovation of new crap in the pipelines.

Small farmers know that regulations are to benefit the big Ag entities and suppress small-scale production that would eat into the profits of the big guys.

Most future innovation will mostly have to do with delivery of goods (in the face of declining energy).

The days of plentiful technological innovations is pretty much gone (patent applications could probably demonstrate this), not so much because of regulations (though they do have impact- sometimes good for the big guys), but because the law of diminishing returns (how the hell to you top most of the stuff that's already out there).  Energy and natural raw materials are key, and as these decline (cheap/easy to extract/exploit) innovation will as well.

Again, I'm not buying it that new innovations can't make it because of "regulations."  Those that have the power to innovate also own the halls of Congress.  Perhaps the reason is, as the article notes, that there's been massive misallocation of and draw on the future?  And, you can lead a horse to water... everyone's hopelessly in debt, innovation is meaningless when you cannot afford it (such is the way for over 4 billion people on this planet, and such has always been the case).

The reversal of economies of scale is upon us.  Nothing else can stem this reversal.