Collectively, the world's major central banks have pumped $1.1 trillion into the markets over the past year.
The result of all this money printing is now well known: massively inflated real estate, stock and bond asset price bubbles, as well as extraordinary wealth and income gaps across society.
Some day all of this insanity will end. But how? Will it unwind in an orderly and polite way, as the world's central planners hope? Or will be disorderly, resulting in painful portfolio losses and mass layoffs?
Michael Pento, fund manager and author of The Coming Bond Bubble Collapse returns to the podcast this week to offer his prediction that events will most likely take the latter route. In fact, he sees the developing inversion of the yield curve as a dependable precursor to the US economy entering recession as soon as this Fall:
The Fed is now raising rates. They raised rates from 0% up to 2%. They're supposed to do it again in September/October. And again in December. That will be four hikes this year.
They are also selling assets, aka 'draining their balance sheet'. I say 'selling' because that's exactly what they have to do. Let's say the Fed is holding a 10-year note that's due: if they want to destroy that money, they say "OK, Treasury, give me the principal". The Treasury doesn't have any money so it has to go the public and raise money. Well, the Treasury will have to do that to the tune of $50 billion per month come October. Right now it's $30, it has to go in July to $40 billion a month then it goes to $50 billion. That's $600 billion a year added to the public supply of Treasurys they have to actually finance at a market rate. That's on top of the $1.2 trillion debt we're going to have in fiscal 2019.
So the Fed is tightening. But here's the problem: the spread between long-term rates and short-term rates is about as narrow as it can be without being inverted.
Right now, as we record this interview the spread between the 2 and 10-year Treasury note is just 34 basis points. That means when the Fed tightens rates in September, which they've pretty much promised to do, assuming the 2 and 10-year note stays at that same spread above the Fed funds rate, we're going to have a yield curve that is almost completely flat. And will be inverted when they go again in December.
Why is that so important? Well, when the yield curve inverts it almost always brings about a recession. In fact, I can say pretty distinctly that in modern times, in this fiat currency regime, given the conditions today, it will definitely cause a recession. The reason is because the fuel for asset bubbles is monetary creation, a boosting booming money supply which we don't have any more. And the reason why the money supply gets shut off when the yield curve inverts is because banks' loans are earning less than their liabilities, which are deposits. So when your assets are earning less than your liabilities, you don't make any more loans. You don't want any more assets. That's a great way to make your bank insolvent.
So what happens is that the money supply gets completely shut off. You're not going to make a loan against a deposit -- you don't even want these deposits anymore. By the way, when there's a recession and there's a withdrawal of asset prices, a contraction in those prices usually results in a run on the bank as well. So asset prices get stumped because there's a run on the bank and these deposits get withdrawn. That is what usually causes causes a recession. And that's exactly where we are going to be come the fall, and even closer towards the end of this year.
Click the play button below to listen to Chris' interview with Michael Pento (35m:59s).