This Artificial Economic Boom Is Coming To An End
Nothing is forever, not even debt. Every borrower eventually either repays what they owe or defaults. Lenders may or may not have remedies. But one way or another, the debt goes away. One of Western civilization’s largest problems is we’ve convinced ourselves debt can be permanent. We don’t use that specific word, of course, but it’s what we do and is why government debt keeps rising. We borrow faster than we repay previous borrowing—and I mean governments everywhere, China as well as the US. Our leaders have no real plan to reduce the debt, much less eliminate it. They just want to spend, spend, spend forevermore. And most citizens are okay with that.
As a result, I think we will spend the latter part of the 2020s going through a kind of worldwide bankruptcy. We won’t call it that, and it will take a lot of argument because we won’t have a court to take charge. But we will collectively realize the situation can’t go on and find a way to end it. I’ve taken to calling this “the Great Reset.” Once the Great Reset is over, we’ll find a much better world waiting for us. Getting there will be the hard part.
The Artificial Boom
A decade of bailouts, QE, ZIRP, and so on encouraged everyone to lever up, and they have. Ray Dalio described this in his latest LinkedIn post.
Because investors have so much money to invest and because of past success stories of stocks of revolutionary technology companies doing so well, more companies than at any time since the dot-com bubble don’t have to make profits or even have clear paths to making profits to sell their stock because they can instead sell their dreams to those investors who are flush with money and borrowing power.
There is now so much money wanting to buy these dreams that in some cases venture capital investors are pushing money onto startups that don’t want more money because they already have more than enough; but the investors are threatening to harm these companies by providing enormous support to their startup competitors if they don’t take the money.
This pushing of money onto investors is understandable because these investment managers, especially venture capital and private equity investment managers, now have large piles of committed and uninvested cash that they need to invest in order to meet their promises to their clients and collect their fees.
In other words, much of what we see right now isn’t real economic activity. It is artificial, incentivized by the monetary policies that ended the last crisis, but should have stopped much sooner.
Now people are beginning to see this emperor has no clothes. The first evidence is in the failure-to-launch of “unicorn” companies like WeWork, whose early investors assumed they could palm off their shares to unwitting IPO buyers. Nope, didn’t happen, not going to.
But that’s minor compared to the other threat they face…
Rising Interest Rates
In case you haven’t noticed, our negative-rate-loving overseas friends are having a change of heart. The Bank of Japan and European Central Bank are plainly looking for an exit from NIRP as their commercial banking sectors find it increasingly impossible to turn a profit.
And whatever many on the progressive left think about banks, they are a critical part of the economy.
Over here, the Federal Reserve’s rate-cutting at the short end is raising rates at the long end and, not coincidentally, un-inverting the yield curve. This is happening, in part, because the Fed is having to “help” the Treasury sell enough T-bills to cover the government’s growing deficit.
This is helping reduce interest costs a bit because shortening the average maturity lets the Treasury pay lower rates. But it also leaves less capital at the long end, pushing those rates higher. And loan demand isn’t shrinking because so many people figured they would keep refinancing forever.
This will change in due course. And as we see debt-laden businesses run into difficulty—often because they were bad ideas in the first place—bankers will tighten lending standards, and the dominoes will start to fall.
I predict an unprecedented crisis that will lead to the biggest wipeout of wealth in history. And most investors are completely unaware of the pressure building right now. Learn more here.
written by: John Mauldin