Sunday, August 12, 2018

The next bubble to burst will be…

Recessions occur when demand gets ahead of our ability to pay for stuff.  Of late (the last 20 years or so), the triggering event for a recession has been the bursting of an asset bubble.  First, it was the Dot Com bubble (or is it .com?).  Then it was the real estate bubble.  The paper gains of assets like stocks and real estate create in us a “wealth effect.”  We feel wealthier than we are and comfortable taking on debt to pay for all that stuff.  When we wake up (or when the bubble bursts), we stop spending so much and the economy contracts.

Cruising channels the other night, I stopped on Bloomberg long enough to hear a Swedish economist who specializes in Asia report that global debt now totals 320% of global GDP, ¾ of it corporate.  (Ya gotta love it: A Swedish Asia expert on American media!  Ain’t globalization grand?)  In other words, corporations and governments have been taking advantage of low rates and central banks’ Quantitative Easing to expand spending and investment that drives GDP growth.  Of course, sooner or later, someone has to start paying back all that debt. It seems that big corporations and banks can keep kicking the can down the road.  However, there are other concerns.  

Long term, the challenge of living up to the obligations that governments have made to citizens will be untenable.  Absent reform of Medicare and Social Security, we may be unable to pay those benefits without taking on debt too heavy for the US economy to support.  The alternatives are to expand the money supply (which QE did to little effect because there was little M2 acceleration) leading to extraordinary inflation, to raise taxes to a degree that will reverse economic growth, or to fail to live up to our obligations.  This extends to states and municipalities (and, indeed, corporations) that can’t pay pensions to which they have committed.  (It should be noted that the unpaid obligations of public pension funds, Social Security, Medicare et al. are not on the books.  In other words, the sum of those obligations is not included in the $320T of global debt.)

So, what does it look like when the bubble bursts?

Some think that the triggering event will be a collapse in the High-Yield Bond market.  (We used to call them Junk Bonds, a more appropriate title.)

To me, it seems more likely that developing countries may suffer a collapse. When countries without a reserve currency enter into international contracts (or development loans), they are generally required to make repayments in a reserve currency, typically US dollars.  As the US dollar strengthens (due to rising interest rates or international strife), it becomes more expensive and, eventually, impossible for those nations and their corporate citizens to repay their debts.  This process could be accelerated by a new tariff regime.  Such an event in one country could trigger a series leading to massive defaults.  This happened in isolated instances in the 90’s. When the Mexican currency collapsed, for example, President Clinton structured a debt package that enabled them to work their way out of trouble.  

Now, of course, the problem exists on a massive scale.  Governments, including the US, are carrying the weight of debt over 100% of GDP (and adding $1+ Trillion per year to it).  Corporations, globally, are carrying more than twice that burden in percentage terms and we don’t account pensions as liabilities.  They are typically described as “unfunded liabilities.”

For several years, the gurus at ITR Economics have been forecasting another Great Depression beginning around 2030.  (They’ve even gone so far as to outline how Millennialsshould prepare for it.) Its causes will be different than its 20th Century counterpart.  It will be caused, in ITR’s view, by the failure of the US government to reform its largest entitlement programs – Social Security and Medicare. 

This scenario is becoming more believable as time goes on.  We have recently been treated to the spectacle of a hypocritical Republican Congress -- which quite correctly criticized President Obama’s huge deficits – pass a tax bill and a budget that creates $1 Trillion annual deficits for the foreseeable future. 

Maybe it’s time to start hoarding gold. 


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