December 20, 2019
God bless Paul Volcker. He was truly a one of a kind central banker, and we probably won’t see another one like him ever again. It took his extreme bravery to crush the inflation caused by the monetary recklessness of Arthur Burns and the fiscal profligacy of Presidents Johnson & Nixon. Raising interest rates to 20% by March 1980 was wildly unpopular at the time. But in the end, it was what the nation needed and paved the way for a long period of economic stability and prosperity.
Back in 1971, the world fully had developed a new monetary “technology.” Governments learned that money need no longer be representative of prior efforts, or energy expended, or previous production, or have any real value whatsoever. It can be just created by a monetary magic wand; and done so without any baneful economic consequences.
This phony fiat money can, in the short-term, cause asset values to increase far above the relationship to underlying economic activity. And now, having fully shed the fettering constraints of paper dollars that are backed by gold, central banks have printed $22 trillion worth of confetti since the Great Recession to keep global asset bubbles in a perpetual bull market. Now, anyone whose brain has evolved beyond that of a Lemur understands that this can only be a temporary phenomenon–one where the ultimate consequences of delaying reality will be all the more devastating once they arrive.
This magic monetary wand is also being used to push borrowing costs down to record low levels—so much so, that some governments and corporations are now getting paid when they borrow. Therefore, it’s no wonder to those of us who live in reality that both the public and private sectors tend to pile on much more debt when both real and nominal interest rates are negative. Indeed, debt has been piling up at a record pace. Amazingly, central bankers find themselves in complete denial when it comes to this reality.
To this point, The U.S. budget deficit for the month of November was $209 billion and is running a deficit of $343 billion for just the first two months of fiscal 2020. And, we have the following three data points from my friend John Rubino at DollarCollapse.com:
- Total US credit (financial and non-financial) jumped by $1.075 trillion in Q3 2019, the strongest quarterly gain since Q4 2007. The total is now $74.862 trillion, or 348% of GDP.
- U.S. Mortgage Lending increased $185 billion, the strongest quarterly gain since Q4 2007.
- M2 money supply surged by an unprecedented $1.044 trillion over the past year, or by 7.3%.
Not only this, but Morgan Stanley’s research shows that nearly 40% of the Investment Grade corporate bond market should actually be rated in the junk category based upon their debt to EBITA ratios. In fact, the entire corporate bond market has a record net debt to EBITA ratio. And, the total amount of US corporate debt now equals a record high 47% of GDP. In the third quarter of this year, US business debt eclipsed household debt for the first time since 1991. And, according to Blackrock, global BBB debt, which is the lowest form of Investment Grade Debt, now makes up over 50% of the entire investment grade market versus only 17% in 2001.
Here is another fun fact: The IMF calculated that in the next financial crisis– if it is only half as severe as 2008–zombie corporate debt (which consists of companies that don’t have enough profits to cover the interest on existing debt) could increase to $19 trillion, or almost 40% of the total amount of corporate debt that exists in the developed world.
The problem should be clear even to the primates that govern our money supply. Global governments have already proven completely incapable of ever normalizing interest rates, and every moment they continue to force borrowing costs at the zero-bound level compels these corporations to pile on yet more debt. This means the corporate bond market is becoming increasingly more unstable, just as it also raises the level from which bond prices will collapse–when not if, the next recession arrives.
And speaking of recession, during the next economic contraction, the US national deficit should rise towards $3 trillion per year (15% of GDP) and that will add quickly to the National Debt, which is already at $23 trillion (106% of GDP). Meanwhile, while US Treasury issuance will be exploding in size, the $10 trillion worth of US corporate debt will also begin to implode. This means the Fed should be forced to purchase trillions of dollars in Treasury debt at the same time it has to print trillions more to support collapsing corporate bond prices.
That amount of phony fiat money creation would eclipse QEs 1,2,3, & the Fed’s currently denied QE 4 all put together. I wonder what name Jerome Powell will put on his non-QE 5 when the time arrives? If investors are unprepared to navigate the dynamics of depression and unprecedented stagflation, it could mean the end of their ability to sustain their standard of living. A totally different kind of investment strategy is needed during an explicit debt restructuring as opposed to one where the government pursues an inflationary default on its obligations. I believe governments will pursue both methods of default at different times. Determining when and how the government reneges on its obligations is crucial. That is what the Inflation/Deflation and Economic Cycle Model SM was built to do. Get prepared while you still have time.