Most Popular
1. Banking Crisis is Stocks Bull Market Buying Opportunity - Nadeem_Walayat
2.The Crypto Signal for the Precious Metals Market - P_Radomski_CFA
3. One Possible Outcome to a New World Order - Raymond_Matison
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
5. Apple AAPL Stock Trend and Earnings Analysis - Nadeem_Walayat
6.AI, Stocks, and Gold Stocks – Connected After All - P_Radomski_CFA
7.Stock Market CHEAT SHEET - - Nadeem_Walayat
8.US Debt Ceiling Crisis Smoke and Mirrors Circus - Nadeem_Walayat
9.Silver Price May Explode - Avi_Gilburt
10.More US Banks Could Collapse -- A Lot More- EWI
Last 7 days
US Interest Rates - When WIll the Fed Pivot - 1st Mar 2024
S&P Stock Market Real Earnings Yield - 29th Feb 2024
US Unemployment is a Fake Statistic - 29th Feb 2024
U.S. financial market’s “Weimar phase” impact to your fiat and digital assets - 29th Feb 2024
What a Breakdown in Silver Mining Stocks! What an Opportunity! - 29th Feb 2024
Why AI will Soon become SA - Synthetic Intelligence - The Machine Learning Megatrend - 29th Feb 2024
Keep Calm and Carry on Buying Quantum AI Tech Stocks - 19th Feb 24
How to Profit from the Global Warming ClImate Change Mega Death Trend - Part1 - 17th Feb 24
Why Rising Shipping Costs Won't Cause Inflation - 17th Feb 24
Intensive 6 Week Stock Market Elliott Wave Training Course - 17th Feb 24
INFLATION and the Stock Market Trend - 17th Feb 24
GameStop (GME): 88% Shellacking Yet No Lesson Learned - 17th Feb 24
Nick Millican Explains Real Estate Investment in a Changing World - 17th Feb 24
US Stock Market Addicted to Deficit Spending - 7th Feb 24
Stocks Bull Market Commands It All For Now - 7th Feb 24
Financial Markets Narrative Nonsense - 7th Feb 24
Gold Price Long-Term Outlook Could Not Look Better - 7th Feb 24
Stock Market QE4EVER - 7th Feb 24
Learn How to Accumulate and Distribute (Trim) Stock Positions to Maximise Profits - Investing 101 - 5th Feb 24
US Exponential Budget Deficit - 5th Feb 24
Gold Tipping Points That Investors Shouldn’t Miss - 5th Feb 24
Banking Crisis Quietly Brewing - 5th Feb 24
Stock Market Major Market lows by Calendar Month - 4th Feb 24
Gold Price’s Rally is Normal, but Is It Really Bullish? - 4th Feb 24
More Problems in US Regional Banking System: Where There's Fire There's Smoke - 4th Feb 24
New Hints of US Election Year Market Interventions & Turmoil - 4th Feb 24
Watch Consumer Spending to Know When the Fed Will Cut Interest Rates - 4th Feb 24
STOCK MARKET DISCOUNTING EVENTS BIG PICTURE - 31st Jan 24
Blue Skies Ahead As Stock Market Is Expected To Continue Much Higher - 31st Jan 24
What the Stock Market "Fear Index" VIX May Be Signaling - 31st Jan 24
Stock Market Trend Forecast Review - 31st Jan 24

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

This Is How You Create the Biggest Credit Bubble in History

Interest-Rates / Global Debt Crisis 2019 Mar 17, 2019 - 05:27 PM GMT

By: John_Mauldin

Interest-Rates

Last week, the ECB announced it would keep record-low interest rates for longer. The news comes shortly after the Fed gave in to the market and held off on further rate hikes.

While investors celebrate the policy reversal, they might soon regret it.

This stimulus may indeed buy the market an additional year or two. But postponing the inevitable downturn with artificially low rates will come at a cost.

The cost is a massive credit bubble that is already of biblical proportions. Its implications chill me to the bone.


Credit Cycles

Here’s a quote from my friend Peter Boockvar—Chief Investment Officer of Bleakley Advisory Group, a $3.5B wealth management firm—which drew an enormous amount of interest:

 “We no longer have business cycles, we have credit cycles.”

This is critical to understand, so let’s cut that small but meaty sound bite into pieces.

What do we mean by “business cycle,” exactly?

A growing economy peaks, contracts to a trough (what we call “recession”), recovers to enter prosperity, and hits a higher peak. Then the process repeats. The economy is always in either expansion or contraction.

This pattern broke down in the last decade.

We had an especially painful contraction followed by an extraordinarily weak expansion. GDP growth should reach 5% in the recovery and prosperity phases. It’s been around 3% (at best) since 2008.

Peter blames the Federal Reserve’s artificially low interest rates. Here’s how he put it:

To me, it is a very simple message being sent. We must understand that we no longer have economic cycles. We have credit cycles that ebb and flow with monetary policy. After all, when the Fed cuts rates to extremes, its only function is to encourage the rest of us to borrow a lot of money and we seem to have been very good at that. Thus, in reverse, when rates are being raised, when liquidity rolls away, it discourages us from taking on more debt. We don’t save enough.

The problem is that over time, debt stops stimulating growth. Hence, the flat-to-mild recovery years.

Debt-fueled growth is fun at first but simply pulls forward future spending, which we then miss. Debt also boosts asset prices. That’s why stocks and real estate have performed so well.

If financing costs rise and buyers lack cash, the asset price must fall. And fall it will.

Further, since debt drives so much GDP growth, its cost (i.e., interest rates) is the main variable defining where we are in the cycle. The Fed controls that cost—or at least tries to—so we all obsess on central bank policy.

And rightly so.

Corporate Debt Disaster

In an old-style economic cycle, recessions triggered bear markets. Economic contraction slowed consumer spending, corporate earnings fell, and stock prices dropped.

That’s not how it works when the credit cycle is in control.

Lower asset prices aren’t the result of a recession. They cause the recession. That’s because access to credit drives consumer spending and business investment. Take it away and they decline.

Recession follows.

The last credit crisis came from subprime mortgages. Those are getting problematic again. But I think today’s bigger risk is the sheer amount of corporate debt, especially high-yield bonds.

Corporate debt is now at a level that has not ended well in past cycles. Here’s a chart from Gluskin Sheff’s Dave Rosenberg:

https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Image_2_20180511_TFTF.jpg

Source: Gluskin Sheff

The debt/GDP ratio could go higher still, but I think not much more. Whenever it falls, lenders (including bond fund and ETF investors) will want to sell. Then comes the hard part: to whom?

Liquidity Crisis

You see, it’s not just borrowers who’ve become accustomed to easy credit. Many lenders assume they can exit at a moment’s notice.

We have two related problems here:
  • Corporate debt issuance, especially high-yield debt, has exploded since 2009.
  • Tighter regulations discouraged banks from making markets in corporate and high-yield debt.

Both are problems, but the second is worse.

Experts tell me that Dodd-Frank requirements have reduced major banks’ market-making abilities by around 90%. For now, bond market liquidity is fine because hedge funds and other non-bank lenders have filled the gap.

The problem is they are not true market makers. Nothing requires them to hold inventory or to buy when you want to sell.

That means all the bids can “magically” disappear just when you need them most.

Worse, I don’t have enough exclamation points to describe the disaster when all high-yield funds try to sell at once and at fire-sale prices to meet redemptions.

In a bear market, you sell what you can, not what you want to. The picture will not be pretty.

Credit Collapse Will Lead to Recession

To make matters worse, many of these lenders are far more leveraged this time.

They bought their corporate bonds with money borrowed at record-low rates. And they’ll continue doing so as long as central banks keep them low.

To make matters even worse, most leveraged corporate bonds are what’s known as “covenant-lite.”

Put simply, the borrower doesn’t have to repay by conventional means. Sometimes it can even force the lender to take more debt.

As the economy enters recession, many companies will lose their ability to service debt. Normally, this would be the borrowers’ problem, but covenant-lite lenders took it on themselves.

This means the macroeconomic effects will spread even more widely.

Those of us with a little gray hair have seen this before, but I think the coming one is potentially biblical in proportion.

Get one of the world’s most widely read investment newsletters… free

Sharp macroeconomic analysis, big market calls, and shrewd predictions are all in a week’s work for visionary thinker and acclaimed financial expert John Mauldin. Since 2001, investors have turned to his Thoughts from the Frontline to be informed about what’s really going on in the economy. Join hundreds of thousands of readers, and get it free in your inbox every week.

John Mauldin Archive

© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in