On the Shrinking Pyramid of Global Liquidity and Why a High-Carb & Low-Fat Diet?-Part 1!

From: aditya rana
Date: Sat, Mar 9, 2013 at 2:25 PM
Subject: On the Shrinking Pyramid of Global Liquidity and Why a High-Carb & Low-Fat Diet?-Part 1!

Hi!,

Global liquidity flows are key to determining the outlook for economies as well as markets, and it is therefore important to develop a framework to estimate global liquidity and predict possible future scenarios and their implications. With this aim in mind, I present below a summary of an interesting note by David Roche, who runs a independent research firm called Independent Strategy out of London:

-The deleveraging process which began after the bursting of the global credit bubble in the summer of 2007, is still underway with global leverage shrinking by 15% from its peak in 2007.

-Liquidity can be viewed as a n inverted pyramid, comprising 1) power money (M1 money supply), 2) bank credit (i.e. loans), 3) debt and 4) derivatives (net exposure).

-Global liquidity tripled from 1990 to 2007 (see chart below-based data is provided by BIS and the IMF) , driving up the prices of financial assets (but not goods and services) as it was primarily dedicated to asset markets in the form of securitised debt and derivatives (i.e. shadow banking).

-The deleveraging since 2007 has been significant and unprecedented, but still remains above its level in 2005 and double the level seen at the start of the global credit bubble in the mid-1990s (see chart below). It is only in 2012 that global liquidity has declined in absolute terms.

-With regards to the components of the pyramid since the credit crisis, power money has expanded significantly as central banks have aggressively eased monetary policy, bank credit has dropped by 20%, debt has declined only marginally while derivatives have contracted dramatically (down 27%).

-While global credit (defined as bank credit and debt) has fallen marginally to pre-crisis levels, it has now begun to rise again in the developed world after being range-bound in the aftermath of the credit crisis (see chart below).

-Global credit appears to follow cyclical patterns in the post 1989 period, rising by double digits during bubbles and falling by low single digits during subsequent corrections, until the post-2007 period when it fell by more than 15%.

-McKinsey estimates that the minimum deleveraging period in the aftermath of a credit bubble is about six to seven years, Reinhart and Rogoff estimate that the process typically takes more than 10 years (and can sometimes be as long as 20 years), while Claudio Borio from BIS estimates 2014 as the earliest end to the deleveraging cycle.

-Extrapolating global liquidity trends since 1996 (when the global credit bubble commenced), global liquidity is still 11% above its trend line and is only likely to return to trend levels in 2015 (see chart below).

-The impact of the deleveraging process has been partially offset by central bank purchases of public and private securities (QE) and keeping interest rates low. By keeping the interest cost below GDP growth rates, the real burden of debt declines over time and has a positive impact on budget deficits.

-However, the excessive debt burden has a hidden cost in the form of encouraging saving over spending, misallocating capital and reducing investment in the economy. Therefore, expect below-trend GDP growth and modest equity returns over at least the next three years.

An interesting framework which illustrates the backdrop under which central bankers around the world are operating and highlights the need for continued QE and low interest rate policies around the world (including emerging markets with regards to low interest rates). The healing process for the global economy (in the form of deleveraging) is far from over, and central banks will need to continue the fight against deflationary forces for a while longer to try and keep economic (and job growth) in positive territory. Open-ended QEs for the developed world are likely to continue well into 2014, and low interest rate polices for even longer (at least mid -2015 for the Fed), thereby keeping the interest cost on their debt at a level below the growth rate of the economy. Improving signs in the economy will paradoxically further the chances of continued QE, as central bankers get more confident about the positive impact of their policies.

Legendary hedge fund manager Stanley Druckenmiller (and ex-partner of George Soros) was interviewed recently and made this pertinent point:

"the thought that you can exit from wherever the balance sheet will be at that time, 4 trillion, wherever it is, in an orderly mannerthe chairman testified that will give the market plenty of warning, do you know what guys like me are going to do when they sell the first bond out of 4 trillion? and don’t think that letting the bonds run off isn’t selling. that debt has to be refinanced. if you do not — if you just let all the bonds run off that is still 4 trillion in selling. and it’s not till they actually sell the first one, it’s till you get the whiff — what do you think — what do you think the markets are going to do when they figure out the exit. look what happened in qe-1 and qe-2 ended which is why I don’t think this is ever going to end."

I don’t know when it’s going to end, but my guess is, it’s going to end very badly; and it’s going to end very badly because, again, when you get the biggest price in the world, interest rates, being manipulated you get a misallocation of resources and this is going to end in one of two ways – with a malinvestment bust which we got in ’07-’08 (we didn’t get inflation). We got a malinvestment bust because of the bubble that was created in housing. Or it could end with just monetizing the debt and off we go in inflation. So that’s a very binary outcome. they’re both bad."

In this environment, as reiterated in previous newsletters, continuing (cautiously!) with the risk-on trade makes sense (for the balance of this year) in the context of a well diversified asset portfolio comprising select developed markets (U.S. quality, Japan, peripheral Europe), EM (particularly China and India), commodity stocks, high-yield credit (HY bonds are highly correlated with stocks as the chart below illustrates, but pay a high coupon as well), EM local currency and $ high yield bonds, cash and, yes, gold (as insurance against open-ended QE policies!).

Why a High Carbohydrate & Low-Fat diet? – Part 1.

Nathan Pritikin was a pioneer in the field of diet and health, by making the case for a largely vegetarian high complex-carb diet to battle heart and other diseases. His life story is remarkable and I present below a note written on him by one of his students Dr. John McDougall, together with the first part of a summary of a path-breaking article (“High Carbohydrate Diets; Maligned and Misunderstood”) he wrote in the Journal of Applied Nutrition in 1976, whichstill resonates today!

“Born in Chicago in 1915, Nathan Pritikin was diagnosed with near-fatal coronary artery disease in his early forties and in 1958 he was diagnosed with a lymphoma (a blood cancer). His highest cholesterol was reported to be 280 mg/dL. Research to save his own life led him to develop a low-fat, low-cholesterol, high-carbohydrate diet to treat epidemic Western illnesses. He was able to lower his own cholesterol to below 150 mg/dL and relieve all signs and symptoms of heart disease. His diet was very similar to the McDougall Diet except for the use of small amounts of skim milk products, lean beef, chicken, and fish (very small amounts). It was also lower in salt and his program emphasized strenuous exercise.

He spent his early life as an engineer and inventor, patenting chemical and electrical products for corporations like Bendix and Honeywell. He never had formal medical training. During his career he published several national best-selling books and his team published over 100 scientific papers in some of the world’s most respected peer reviewed medical journals.

After his death in 1985 when he finally succumbed to the blood cancer (after 27 years!), a thorough autopsy was performed and the results were published in the New England Journal of Medicine. His heart was remarkably free of disease and the coronary arteries were completely open, proving one last time that he was right.”

Summary of article-Part 1:

-The low incidence of arterial clogging in populations on low fat diets has been widely observed by many investigators. The coronary heart disease rate of the Bantus in Africa who live on a 10% fat diet is almost zero. In autopsies performed on 42 Bantus and 22 Europeans who had died suddenly for any reason, only one Bantu had artheoscelrosis; whereas 100% of he Eruopeans, including a youth of 15, had extensive artery damage.

-Autopsies conducted on 600 natives of New Guinea whose diet contained 10% fat and only 7% protein, revealed only one case of heart disease. Blood pressure in New Guineans was found to drop by 10mm when in their 60s.

-A study of a population in Ecuador which had an unusual number of aged people – out of a population of 100 villagers, a number were over 100 years and one was 121 as per Catholic Church records – found no incidence of heart disease and their diet consisted of mainly complex carbohydrates, corn, brown rice, beans, various other vegetables and fruits and only a weekly serving of animal protein.

-A study of over 25 populations arou nd the world on a low fat diet showed that, without exception, their heart disease rate was very low.

-Immunity to heart dsease lasts only as long as a low fat diet is maintained – a study of Japanese who changed their enviornments from their homeland to Hawai and then to the U.S. – showed that as their fat intake increased, so did their coronary heart disease rate.

-Low cholesterol levels were key – the Bantus has cholesterol levels of 90-120 mg, New Guineans of 100 mg, Ecuadorians averaged 100 mg, and the 25 populations in the above study all had low cholesterol levels, without exception.

-A controlled study being currently undertaken on 38 adults with an average age of 60 years, all with advanced artherosclorosis and cholesterol levels of between 200 and 300mg and a myriad of other health problems, were put on a 80% complex carbohydrtae diet with astonishing preliminary results: cholesterol levels dropped by 30% during the first two weeks, after a month all the nine adults with hypertension were able to get of drugs and maintain normal blood pressure, and after 6 weeks all the four diabetics were able to get off their drugs.

To be continued!

Here is to transitioning to a high complex carb and low fat diet!

Regards,

Aditya

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