Deep in Debt

The next crisis is going to be due to debt. 2000 saw the dot-com bubble, and the Great Recession was due to subprime housing securitization. This time is different. A decade of QE, ZIRP and NIRP has resulted in misallocation of capital, which is naturally bad for capitalism. Corporate share buyback programmes have buoyed Wall Street and increased corporate debt. At the same time government spending had to be financed by borrowing in order to cover the yearly deficits. Total US debt is now around $40 trillion (T) as opposed to about $30T in 2010 and about $20T in 2000. There is also the problem of underfunded pension funds in the US and EU, and these promises are really debts according to John Mauldin.

The recent rising strength of the US dollar has put EM under pressure because EM debt in dollars now weighs more heavily upon them. This has been caused by the Fed trying to “normalize” interest rates and scale down its balance. This looming credit crunch was briefly examined in the last Newsletter.

Greece, Italy, Spain and Portugal are saved by ECB purchases. China has gone deep into debt as its economy continues to expand although the possibility of a trade war with the US could cause trouble. In this context Russia and Switzerland are much better off and have avoided excessive indebtedness.

So while Wall Street continues its upward march unperturbed, the credit market is heading towards a crisis due to the Fed raising rates. The ECB has made known its decision to end QE this year, which will mean turmoil for European bonds. If the BoJ stops buying, Japan will undergo a market tsunami.

The capital question of liquidity must be considered. With China and Russia working together to dislodge the US dollar as the main global reserve currency and the Fed practically tightening credit, the excessive debt of the global financial system has created a really serious risk that will probably lead to a liquidity crisis that will cripple the global economy.

It is because of this combination of negative factors that the trade war between the US and its trading partners, particularly China and the EU as well as Japan, could become the spark that ignites the conflagration. Investors should pay close attention to developments regarding the imposition of tariffs, rising interest rates and tightening credit. The stock market will eventually take note of what is happening and react accordingly by heading southwards.

Walter Snyder



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