Since 2007 global debt has risen by $57t, or about 3 times faster than inflation. The biggest increase was in home mortgages.  The Economist magazine (Feb. 7/15) says 10 countries have debt ratios of more than 300% of GDP.  This will prove to be a huge burden for these governments moving forward.

Nobody talks about all the money that is wasted on interest charges from passed outstanding debt.  In the case of the U.S., USdebtclock.org estimates it has paid $2.567t, or $8,012 per citizen.  Sadly, almost all national borrowing is used to keep government’s alive rather than building wealth.

The Baltic Dry Index, which measures the cost of shipping, has set 40 year record lows almost every trading day since the first of the year.  This signals that world trade is falling off a cliff.  Either no one notices or nobody cares.

Stock markets are outperforming their country’s growth.  Interest rates are generally around 1%, yet few people want 4% dividend paying shares (banks, utilities, pipelines).   For Canadians who qualify for the Canadian Dividend Tax Credit the yield is close to 5%.  If income was important to people those 4% dividend shares today would trade closer to a 2.5 to 3% yield (share price would be higher).

Today, we are experiencing the longest period (86 years) between depressions.  We could be overdue for a major correction.  There is nothing the politicians and Central Bankers can do to stop it once it begins.  They can only delay the action by a few weeks or months.

These are confusing times.  This means you must protect you wealth.  Investors should eliminate all debt and build up cash reserves.  In periods of deflation cash is the number one asset to hold.  After that come hard assets like farm land and blue chip securities.

We seem to be the only ones who think this, but when interest rates start to rise they will climb faster than anyone expects.  We can see 10% early next decade.  The world is awash in currency especially the U.S. dollar.  Deflation has had a nasty habit of wiping out currency causing a sudden shortage of cash.  As a result, demand for money rises and so does the price of it.  Do not take any unnecessary risk with your savings.

The Weaker the Better?

We are told that a weak currency helps to increase the sale of our imports, which they do more often than not.  But, this is only a true benefit if the product does not require imported goods for its production. Not to mention, a weak dollar drives up the price of all end-user products, most of which line big-box store shelves.  The end result is reduced consumer spending.  In order to compensate for the fewer sales, retailers will often hike the prices of other products in an attempt to generate more revenue, which only contributes to the problem.  

If your business delivers goods or services, or if it depends upon utility costs to operate but your currency is losing value, then your overhead costs will increase.  In either scenario, you have only three choices; pass on the higher cost to the customer, absorb the higher cost and compensate by cutting quality, or take a financial loss. None of the above is favorable to business.  Clearly, the benefits of a cheaper currency are outweighed by the negatives.

A strong currency should be a priority for all governments.  Why?  Because every rich country under a floating exchange rate has prospered under a strong currency policy.  Between 1960 and 1990, the hottest currencies were the Japanese yen, the German mark, the Dutch guilder, and the Swiss franc.  Both the mark and franc started out at roughly $0.24CDN and climbed to $0.80 and near par, respectively.  In the sixties it took over 300 Yen to buy one U.S. dollar.  At its peak, it required only 88 yen to buy a dollar.  All four countries had low unemployment and prospered while their currency increased in value.

The 1990's belonged to the U.S. dollar as it soared against all currencies.  On January 21, 2002 the Loonie hit an all-time intraday low of $0.6175U.S.  During these 18 years, our economy did nothing.  We had high inflation, high interest rates, and above normal unemployment.  America, under a strong currency, boomed.  Its only major problem was the lack of skilled workers.  This was the period that gave birth to Silicon Valley.

From January 2002, the Loonie was the world’s best performer, only to close at an all-time high of $1.10U.S. in November 2007.  Between 2002 and 2007, Canada was amongst the most robust economies in the world.  Today, the hottest currencies are the Swiss franc and the U.S. dollar.  Guess what?  These two countries have the strongest economies.  

If history is about to repeat itself, Canada is in for below average growth. This should not be the case though because we have the best opportunities in the world.  Unfortunately, the Bank of Canada and Ottawa are intent on weakening us.  Sadly, they are going to succeed.  All the Bank of Canada must do is hike interest rates slightly and capital will flock here, improving our economy overnight.  Canada and the U.S. currently have identical trade deficits, our GDP growth is similar, and we have far less debt. We have far more resources, a better education system and a larger middle class. 

There is no reason why the Loonie should not be worth at least par.  Every day that it is not, is another day our dollar is undervalued against the Greenback. The longer our dollar continues to fall, the worse it will be for all Canadians.  A strong economy will only return when the dollar starts to rise and Ottawa rewards savers at the expense of the indebted.

Q3 GDP increased 5% in the U.S.  This is great news and indicates that the U.S. economy is taking the world by storm.  If this was the case, then why do interest rates fall under such good news?  Also, after falling 0.2% in the same quarter, why are wages not climbing either? Both interest rates and wages should be rising during a period of such robust growth.  

Let’s take a closer look at the GDP numbers.  First off, our neighbour’s love of defence and war spending continues to add 0.80 basis points (bps) to GDP.  However, the largest gain came from personal consumption (221bps), which is great news.   But the largest growth came from spending on services, which accounted for 115 basis points.  Of this amount, 15 bps was non-profit spending, while the remaining was divided between Healthcare spending and Financial Services/Insurance.  In short, 85% of the contribution to GDP from household spending came from Obamacare, rather than spending on tangible goods that create jobs such as TV’s and cars.  With this in mind, is the U.S. economy really taking off? 

Trade between China and the U.S. finished 2014 off with imports and exports declining 10% and 15%, respectively.  Overall, how can growth in an economy be legitimate if imports and exports declined? 

A dysfunctional American government does not help.  At $18.1t, their government debt is out-of-control.  If they ever want to tackle their liabilities, which appear doubtful, it will take generations to put their finances back in order.  Washington appears happy that they have given their corporations the highest taxes in the world.  It’s odd that they can’t figure out why so many companies have sheltered trillions of currency offshore. 

Shale oil has proven to be a boost to the American economy.  It has created jobs and less imported oil, yet it has had no influence of the country’s trade deficit.  We estimate that after 2018, America will have to increase oil imports.  America is into its 43^rd year of consecutive monthly trade deficits.  This is hardly a sign of a healthy economy.

Boeing and the farmer are the only two segments of the economy keeping the trade deficit from being a complete disaster.  Boeing is conducting robust business delivering new aircraft.  The company has a huge backlog that will keep the company busy well into the next decade.  Soon, Boeing will begin building a revamp version of the 737.  It is worth noting many parts of Boeing airplanes are made in Canada, benefiting mostly Ontario, which needs all the help it can get. 

The Baltic Dry Index, which tracks ocean shipping rates, is trading at its 25-year low.  This is indicative of a weak world trade.   The CRB Index is also sliding.  At today’s level, off 16% from a year ago, it means we have entered deflation.  The lower this index goes, the more damage deflation will do to the economy.  Deflation is a job killer and destroys wealth that is backed by debt (aka real-estate). 

We hate being the bearer of bad news but the U.S. economy is nowhere near as robust as their metrics lead us to believe, nor will it be able to pull the world economy from driving into the ditch.  We still need to eliminate the excesses of commodities, real-estate, and nearly every other good we created over the past two decades before new organic growth can take place.  We cannot see this taking place until 2018, at the earliest. 

Quantitative Easy (QE) is being praised as a success.  This monetary policy is where a central bank issues new money (essentially creating it from nothing), and uses it to purchase assets from other banks. Ideally, the cash the banks receive for their assets can then be lent to borrowers. The idea is that, by making it easier to obtain loans, interest rates will drop and consumers and businesses will borrow. Theoretically, the increased borrowing will result in more consumption, which fosters job creation and, ultimately, creates economic growth.

QE has been a failure because it has resulted in very little true economic growth, if any at all.  The main outcome from the monetary policy is that interest rates have been pushed to historical lows and debt to historical highs.  One of the main outcomes is business has used lower interest rates to issue bonds and use the proceeds to purchase its own stock.  This results in increased earnings per share, causing a rise in share prices.  Business is also using the low interest rates to invest in government debt and stocks rather than building plants and equipment. 

The world economy will bounce along because consumers must spend X amount every day to eat, sleep and for health needs.  This is basically a constant for all economies.  Where the problem lies, which those in charge of government and monetary policies do not understand, is the consumer needs extra income to give an economy a boost. This has not been the case.

As the chart above illustrates, real (adjusted for inflation) median household income in the U.S. is roughly 6% percent lower than it was in June 2009 (the month the recovery technically began), 7 percent lower than in December 2007 (when the most recent recession officially started); 8 percent lower than in January 2000, and only 5% higher than 1995. 

Currently, after-tax wage growth around the world is less than the rate of inflation.  The U.S. has averaged a 1.6% inflation rate since 1995.  Using the data from the chart above, the average American has lost roughly 1.2% of their purchasing power every year since 2005.  For those who are retired, they are getting poorer by the day because low interest rates are causing them to spend their capital at a much faster rate.  This would not be the case if their savings generated a larger income.

In today’s economy, the only way to increase ones passive income is to pick dividend paying shares in a company that raises the dividend each year by a minimum 3%.  One can also pick the right investment to earn capital gains, which has far more to do with luck than brains.  Since probably 80-to-90 percent of people only invest in various types of bank accounts, the majority of savers are sliding backwards even faster thanks to the low interest rate policies that plague the world. 

An economy needs to place as much discretionary income into the consumers’ pocket as possible.  This cannot be achieved by accommodating the borrower with historically low interest rates.  Contrary to the government’s way of thinking, it is the saver that drives the economy, not the borrower.  After all, one cannot lend what you do not have.

There are plenty of things governments can do to stimulate growth and put money into the hands of the consumer.  However, for some unknown reason they do not want to.  Instant results would be realized by lowering personal income taxes and the GST, or by eliminating the destructive capital gains tax.  Governments can also allow a certain amount of passive income to be earned tax free.

Rather than favoring monetary stimulus (QE), which has been a failure, governments should focus on fiscal stimulus such as increase spending on building better infrastructure.  Improvements need to be made in all corners of the world.  This type of spending creates well-paying jobs, which is the key to a prosperous economy. Furthermore, these types of projects tend to pay for themselves by keeping the economy going, which generates taxes along the way.

There is no benefit to catering to the overleveraged.  If one is overextended, it is going to bite them in the rear no matter if rates stay where they are or not.  It may sound a little radical, but the best solution would be to hike interest rates to a level that benefits the saver at the expense of the over-leveraged.  It makes more sense to force a bankruptcy, which one is cleared of in a few years, rather than have the person’s income pay the debt off over 15 or 20.

Asset prices are going to revert to the norm no matter what.  The only factor we can dictate is the duration it will take.  The route governments are taking is simply prolonging the contraction phase of the economy.  Until governments get serious about placing money in the hands of the consumer and rewarding savers, the world economy is going to continue to drift downward.  The stock markets will eventually follow.

Hedge Funds emerged in the early nineties as an investment for wealthy investors.  By 1998, Long Term Capital Management (LTCM) was one of the largest.  It attracted the wealthy in New York and Washington, because the fund was a sure bet.  Afterall, the two people running it, both of whom won a Nobel Prize for economics, had figured out how to beat the stock markets.  Unfortunately, their theory failed in 1998 and the fund became insolvent.  The pursuing market crash nearly took down all stock markets around the world.  As a result, investors in Hedge Funds quickly liquidated their holdings, and much of the industry went into hibernation after a good two-thirds of funds went broke. 

After a few short years, investors returned to Hedge Fund investing because the funds only hired the best brains in the investment business.  By 2007, there were 15,000 hedge funds across the globe.

Hedge Fund managers became rich overnight because of their “Two and Twenty” fee, which entitled the fund to an annual 2% for management fee, plus 20% of all profits earned.  A small hedge fund, employing roughly 20 people, would easily generate a hundred million in fees per year.  It needs to be pointed out that during the 2008 implosion, the average fund lost 23%, and, not surprising, not one fund gave investors back their management fees.  After 2008, investors began withdrawing their money.  Within months, there were only 4,500 hedge funds remaining. 

The stock markets have done well the past couple of years.  This has created a surge in new Hedge Funds.  Today, there are 11,000 funds world-wide controlling $2.9t.  Because of the amounts these funds manage, stock markets can only offer so many opportunities for them to invest in.  As a result, they are now investing in private companies that cannot be openly traded.  We do not recommend these investments for conservative investors because this increases the risk level for the simple reason; how does one value a private company on a daily basis? 

CalPERS, California’s main public pension fund, is the sixth largest in the world.  Over the past 20 years, the fund has averaged an 8.4% annual return.  CalPERS farmed out some of their money to hedge funds over the past few years.  Recently, they fired every hedge fund as most never came close to equalling what the pension fund did on their own.   All investments will now be done ‘in house’. 

While a handful of Hedge Funds make investor’s money, the majority rarely do.  If this was not the case, the number of Hedge Funds would remain stable, rather than watching half of them close within a year in any down market.  We expect many of the funds to disappear in the months ahead.   

All Hedge Funds are high risk.  We recommend one avoid these investments.  Buying blue-chip securities that pay a regular dividend will outperform most hedge funds over ones lifetime.  This will remain the simplest, and most profitable, method of investing.