Did The Debt Bomb Suddenly Stop Ticking? by Evergreen Gavekal
“Low interest rates cause secular stagnation: they do not cure it.” – CHARLES GAVE
“Negative interest rates are the dumbest idea ever.” – JEFF GUNDLACH, the new “King of Bonds”
“Laugh but listen.” – WINSTON CHURCHILL, addressing the British House of Commons, warning it once again of the rising threat posed by Nazi Germany, to derisive laughter.
- Overwhelming amounts of government debt are among the “rich” world’s biggest threats. Unfortunately, the political will to cope with this—and the related problem of runaway entitlement spending—is nil.
- Radical monetary measures—such as quantitative easing (QE), plus zero- and negative-interest rate policies (ZIRP and NIRP)—are not stimulating growth. Instead, they are producing stagnation, “lowflation”, deflation, and currency wars.
- However, they have stopped the ticking of the debt bomb. They are also reversing the disadvantaging of younger generations at the expense of the older and wealthier; the latter are the big losers from the eradication of interest rates.
- Investors need to adjust to ZIRP and NIRP. They are likely not going away anytime soon.
- These also make it less probable the US government will resort to high inflation as a form of “stealth default” on its immense debt.
- Central banks printing money to buy government bonds is supposedly the pain-free way to extinguish crushing debt burdens. However, there is no free lunch.
- Monetary authorities are finally realizing QEs, ZIRPs, and NIRPs, are failing to catalyze growth. Discussions about banning high-denomination currency (like $100 bills) are gaining steam as is a debate about the merits of doing “helicopter” money drops (direct money transfers to citizens).
- The Fed suspending its rate normalization scheme (after just one hike!), and the European Central Bank unveiling a raft of extreme easing measures, have triggered rallies in almost everything since early February. Energy, Canadian REITs, and gold mining stocks have been by far the stars.
- US stocks are still trading way above the trend-line growth rate of the economy (GDP). There is always reversion back to that and even below.
- Not trying to be Davey Downer but if things are fine why are QEs, ZIRPs and NIRPs necessary? And why is the US middle class so despondent?
- There are a growing—and disquieting—number of parallels with the 1930s, though, also many differences.
- Some good news: in addition to zero interest rates and tepid growth forestalling the day of debt reckoning, they may be creating a trading range market. Perhaps a vicious bear episode can be avoided, or at least delayed.
- However, investors need to be nimble and contrarian. It’s imperative to overweight those areas—like energy-related last year—where money is fleeing en masse. A passive 60/40, stock/bond, portfolio won’t produce the kind of returns investors desperately need.
The best laid plans…
One of the most pressing questions of our time simply must be: How will the developed world cope with its ever-growing mountain of debt? Despite what some have erroneously called The Great Deleveraging, recent years have seen the global mass of liabilities continue to swell at a rate that puts the continually-erupting Kilauea volcano on Hawaii’s Big Island to shame. If that seems exaggerated, consider that nearly $60 trillion has been added to what was already a towering heap of IOUs since 2007.
Not long ago, fears of this dominated the thinking of policymakers, economists, and even regular mom and pop investors. The existential threat from this debt explosion was admirably addressed several years ago by a bipartisan piece of proposed legislation: Simpson/Bowles. Oh, yeah—remember that blast from the past? The only problem is that it was not just in the past, it also never passed.
But here’s the rub: maybe it didn’t need to be; maybe we’re better off without it. Before long-time EVA readers think I’ve taken leave of what senses I still possess, please allow to me to explain (which is emphatically not to endorse). The period since the Global Financial Crisis—the worst modern economic and market calamity other than the Great Depression—has seen the world’s leading central banks engage in ever-more “creative” strategies to reignite growth and, ironically, inflation. The irony is that for most of their existence, entities like the Fed were continually battling too much inflation, not too little. Further amping up the ironic meter is that trillions and trillions of money fabricated by central banks has created “lowflation” and even deflation.
As many EVA readers know—but few can comprehend—increasingly desperate inspired central bankers have, in recent years, resorted to negative interest rate policies (NIRPs). Ostensibly, these have been implemented to catalyze economic growth. Yet, much like zero interest rate policies (ZIRP) and the now infamous quantitative easings (QEs), the evidence on the ground—as opposed to the academic ivory towers—is that these have almost no positive impact on GDP growth. This is even according to a recent Fed study!
And when it comes to inflation, NIRP, ZIRP and QEs have all been factors in bringing back that dreaded vestige of the 1930s: currency wars. As these competitive currency devaluations have spread around the globe, they have created declining commodity and import prices—at least for those countries that have fallen behind in the debasement cycle.
When this happens, a country (like the US over the last year-and-a-half) begins to run a larger trade deficit. Its companies have a hard time selling their products and services, putting downward pressure on earnings. This typically leads to layoffs and, if severe enough, can cause a recession. You may have noticed (and we’ve tried to help in that regard!) that the US corporate sector is almost certain to have endured three straight quarters of falling profits. Even two in a row is considered an earnings recession.
For awhile, the stock market seemed quite agitated about this outcome. Lately, though, with the Fed at least temporarily halting its official tightening cycle after the heroic move of one lone increase, and the European Central Bank going nuclear on its easing measures, stocks have bounced back close to their highs from last summer. As you may recall, this was right before the August “crashette” that saw the Dow fall 1100 points in less than an hour.
Let’s stop for a moment and recap what these lords of the financial kingdom have wrought…
Paradise (accidentally) found?
Ok, so thus far, ZIRP, NIRP, and “From Here to QE-ternity” monetary policies have given us:
- The worst economic expansion in modern history.
- The lowest interest rates since the Middle Ages, if not antiquity.
- Falling inflation-cum-deflation.
- Corporations around the world leveraging up to acquire other companies (and, of course, instituting mass layoffs once the deals go through) and buying back their own stock. These have come at the expense of normal levels of capital spending.
- Related to 4, and the “cap-ex” plunge, we’ve seen a collapse in productivity which is essential for economic betterment, particularly in aging societies
- Asset bubbles in everything from collector cars to penny stocks to Manhattan penthouses to, Seattle apartment buildings, to…well, you name it, and the central banks have almost certainly inflated it; many now appear to be leaking oxygen at a steady, if not rapid, rate.
Notice there aren’t any opinions in the foregoing half-dozen points, just observations. You don’t have to have a PhD