Adrift - Part II

"Let every man, every corporation, and especially let every village, town and city, every county and State, get out of debt and keep out of debt.  It is the debtor that is ruined by hard times." - Rutherford B. Hayes 

In order to stimulate the global economy it has been decided by the Federal Reserve and other central bankers that the only way is to print and monetize debt.  Back in 2005 the global public total debt was $27 trillion.  Ten years later this amount has more than doubled to $57 trillion.  As I mentioned in last week’s blog a lot of this debt is dollar denominated and while the “external” dollars are loosely controlled by the Federal Reserve there is still a level of control far in excess of the US's global economic clout.  This massive debt experiment was supposed to have achieved full employment and global prosperity but it seems to have done anything but that.

Taking a look at the incredibly weak employment numbers coming out of the US and one can see that things are anything but rosy.  Furthermore more than 94 million Americans or 38% of the total workforce are not even looking for work.  This is the lowest labor participation rate 38 years!  Inflation (according to the Federal Reserve) is close to a deflationary number and in many parts of the globe deflation has already taken hold.  In many countries interest rates are negative and still there is no end in sight to the low interest rate environment or even how low these rates can go.  I continue to believe that rates will go even lower for the simple reason that the global economy cannot be repaired with more debt.

As I have mentioned before adding more debt has the effect of crowding out market participants, clogging up the wheels of free enterprise and creating a drag on global growth.  In a chilling statistic the large cap stocks of the S&P 500 as a group paid out through stock buy backs and dividends all of their operating earnings last quarter.  No money was therefore spent on capital from which to grow.  Capital spending includes research and development, capital projects, factory expansions and heavy equipment and machinery purchases.  Money for operations was found in the debt market and used to buy stocks and pay dividends.  No wonder there is an ever increasing social divide!

This party is a massive problem for many reasons however it can last for years as long as low interest rates remain the norm.  Furthermore if those low interest rates are locked in for 20 or 30 years then there is also a benefit however this is not the case.  In fact there is almost $2 trillion of corporate debt coming due between now and the end of next year.  Now it appears that interest rates will remain low through that time however the spread between investment grade credit and junk is starting to widen to levels that are going to cause problems for a number of the companies planning to refinance.  This increasing spread is an indication that not all is well in the credit world and that there may be problems looming.  Should the Federal Reserve raise rates not only will this lead to a large increase in company defaults but the government itself would see a large increase in the deficit as the interest paid on its massive $18 trillion debt would rise pretty quickly. 

The main issue though is that at some point debt becomes deflationary and I think that we may have already reached that level.  Think about it in terms of your personal finances; if you are burdened with debt you cannot spend money on goods and services but are forced to pay down the debt.  The same occurs with businesses and, at some stage, government.  Companies already seem to have lost the incentive to grow their businesses mainly because there is no perceived or anticipated global GDP growth.  Instead they are juicing their numbers and their upper management with dividends and stock buy backs.  The has or will lead to a situation where companies are so burdened with debt that instead of using profits to fund growth it is used to pay down debt.  

The same happens with governments; they have issued so much debt that they are crowding the corporate world out and are getting to a tipping point where they will need to start to repay their debt.  With all eyes focused on paying the debt back not only is this not inflationary it in fact leads to deflation and slow growth both of which are being witnessed before our eyes.  Until there is some expectation of global growth large businesses will continue their financial trickery widening the social divide and removing any chance of a return to normalcy.