In the March 1st edition of The Credit Strategist, editor Michael E, Lewitt ponders the fragility of an economic system together by debt, and briefly touches on the consequences if/when the debt-fueled economic house of cards comes tumbling down.
Lewitt uses Shakespeare’s Hamlet as a cautionary tale regarding the dangers of debt. “Debt is not merely a contract between two parties; it is a solemn pact of trust. When it is sundered, not only is money lost but husbandry – the management of society’s resources – is corrupted. We learn from Shakespeare’s great drama that a world ruled by debt is extremely fragile.”
The central thesis of Lewitt’s argument is that the vast majority of financial professionals today are wearing tightly cinched blinders and literally refuse to see the global debt elephant in the room. “Today’s investment landscape is filled with investors, strategists and media pundits who refuse to admit that we no longer live in a world that can pay its debts or respond to monetary stimulus as it did in the years before the financial crisis.”
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The growing global debt bubble
Debt has grown exponential rate world wide over the last few years while the global economy has “crept along at a petty pace.” More than six years following the financial crisis, global debt is booming and interest rates are still below zero in much of the developed world. According to Lewitt, this is a clear “sign that policy makers have failed to create sustainable economic growth. They have managed to inflate financial assets but left the real economy behind.”
He points out that U.S. equity prices are up a startling 122% since 2009, but US nominal growth is only up 18% over the six years. He argues that policy makers are now trying to use currencies to stimulate growth after having “exhausted their ability to employ interest rates as a policy tool.” That said, he says to keep in mind that currencies are themselves “nothing more than a form of debt, a promise by a sovereign. And those promises are being actively debauched in a series of currency wars that are certain to end badly for those who depend on fiat money for their daily bread.”
U.S. economic growth remains anemic, global growth slowing down
Lewitt notes that Figure 2 (by Societe Generale’s Andrew Lapthorne) illustrates that downgrades in U.S. earnings forecasts in February were the largest since the 2009 financial crisis. This means it is almost inevitable that S&P 500 revenues will experience their first year-over-year decline since the financial crisis, and there’s a very good chance earnings will also slip. Lewitt argues that “The sharp drop in oil prices is a symptom rather than a cause of a global economic slowdown that is showing up in a broad array of data.”
Almost tongue in cheek, Lewitt points out that “Nobody, of course, is forecasting a recession. We are taught that recessions do not occur until the Fed tightens aggressively and the yield curve inverts. While the yield curve has flattened significantly over the last year, it is far from inverted. Whether this historical rule will apply at zero gravity remains to be seen.”
Fed is consistently overoptimistic
The Federal Reserve published a paper last month titled Persistent Overoptimism about Economic Growth (February 2, 2015, FRBSF Economic Letter 2015-03) which determined that since 2007, the Federal Open Market Committee has consistently been overly optimistic about U.S. growth. The authors of this paper (Fed employees) say this overoptimism relates to several factors: ignoring relatively obvious warning signals about financial imbalances, overestimating the efficacy of monetary policy and extrapolating past events into the future.