RedmondLonghorn
Footballguy
My first post here isn't inherently political, but I am going to file it here just the same, since I have an idea how the discussion may go.
I am going to stick to the facts with relatively little editorializing in this first post too.
--The Fed and the world's other major Central Banks have kept interest rates extraordinarily low for almost a decade now and have also been injecting liquidity into the system with asset purchases to a degree that is actually shocking when you look at it. While the US Fed has just begun to reduce the size of its balance sheet (meaning it is now removing liquidity from the system), other central banks continue to buy financial assets. They are doing all of this in the name of fighting deflationary forces.
--As a result of very low interest rates and Central Banks actually buying things like corporate bonds, the absolute yields on bonds with some real risk are very low and the spreads between bonds of different levels of risk is extremely narrow. This is important because it means risk is being mis-priced because of an artificial mechanism. This has the potential to cause real problems because it encourages all sorts of imprudent or even reckless behavior on the part of both borrowers and bond investors/lenders.
--All of this excess liquidity also has caused financial assets of all types (bonds, stocks, real estate, etc.) to essentially do nothing but go up in value. The result is a massive gain in value of financial assets. That sounds good, but it is artificial. When you actually look at the value of those assets compared to something tangible like incomes or GDP, things start to look a bit dicey. It also has had the affect of greatly expanding the wealth gap between the wealthiest people (who tend to own lots of financial assets) and those who have little financial wealth. It particularly disadvantages renters, since they get left behind by not owning a home and they often get hit with higher rents as well.
--Extremely low interest rates have also encouraged major countries around the globe to pursue deficit spending policies, from the central government level on down to local municipal levels. The result is that many major countries (and Belgium too, apparently, no idea why it is on this chart) have never been more levered. That particular version of this chart shows the US as less leveraged than it was after the financial crisis, but I am not sure that is true.
--But governments are not the only entities that have had an increased appetite for debt while it has been cheap. Corporations around the world have also gorged on debt. Large US corporations (as exemplified by the S&P 500) have never been more leveraged. (Note: EBITDA stands for Earnings Before Interest, Taxes, Depreciation & Amortization, a crude measure of available cash flow for debt service). The US corporate sector as a whole has never had more debt, relative to the size of the economy. Many of these companies have been issuing debt in order to fund stock buy-backs. Financial theory suggests that is the right thing to do, but there are some pretty big real world caveats. One is that if doing so increases risk of insolvency meaningfully, it is probably a pretty bad idea. The second is if they are borrowing money to buy back shares that are grossly overvalued, that tends to be a pretty bad trade over time.
--One relative bright spot, is that US households aren't quite as indebted as they have been in the past, even if they are deeply in debt relative to a longer history. As bright spots go, that isn't too terribly reassuring.
So a decade or so of Central Bank policy has led to an increasing wealth and income disparity and has also led to there being a lot more debt outstanding than there was heading into the 2008 financial crisis. And the compression in rates and yield spreads has also benefited asset speculators and aggressive investors at the expense of savers and conservative investors. The low absolute rates also likely caused many investors (and I don't just mean individuals here, I am talking institutional investors) to accept levels of credit risk in their portfolios that they would have otherwise shunned, because they had to seek some kind of yield.
Now, after years of Bernanke and Yellin, we have a hawkish Fed chairman and a President that is pushing an inflationary agenda (increased deficit spending and protectionism both being inflationary). There are signs of accelerating inflation that are starting to perk up and the FOMC (Fed Open Market Committee) is now expected to boost the Fed Funds rate significantly this year. Bond investors are starting to get nervous and some long-time bond bulls have declared that the multi-decade bull market is over. (That means they expect bond prices to go down, which means yields go up. The market yields on longer term government bonds are what set longer term interest rates, not the Fed.)
This isn't 2007/2008, because while there are lots of warnings signs that long term imbalances need to be resolved, there isn't a clear path to total disaster like there was at that time (the housing market and subprime mortgage debt). It is likely there are some nasty surprises out there lurking in the weeds, however.
One also wonders how an economy that has only barely gotten past stall speed with the assistance of massive doses of cheap debt will do when it is cut off from that performance-enhanced drug. The fact that rates on adjustable rate debt will start going up at the same time is a bit of a double whammy on that front.
I am going to stick to the facts with relatively little editorializing in this first post too.
--The Fed and the world's other major Central Banks have kept interest rates extraordinarily low for almost a decade now and have also been injecting liquidity into the system with asset purchases to a degree that is actually shocking when you look at it. While the US Fed has just begun to reduce the size of its balance sheet (meaning it is now removing liquidity from the system), other central banks continue to buy financial assets. They are doing all of this in the name of fighting deflationary forces.
--As a result of very low interest rates and Central Banks actually buying things like corporate bonds, the absolute yields on bonds with some real risk are very low and the spreads between bonds of different levels of risk is extremely narrow. This is important because it means risk is being mis-priced because of an artificial mechanism. This has the potential to cause real problems because it encourages all sorts of imprudent or even reckless behavior on the part of both borrowers and bond investors/lenders.
--All of this excess liquidity also has caused financial assets of all types (bonds, stocks, real estate, etc.) to essentially do nothing but go up in value. The result is a massive gain in value of financial assets. That sounds good, but it is artificial. When you actually look at the value of those assets compared to something tangible like incomes or GDP, things start to look a bit dicey. It also has had the affect of greatly expanding the wealth gap between the wealthiest people (who tend to own lots of financial assets) and those who have little financial wealth. It particularly disadvantages renters, since they get left behind by not owning a home and they often get hit with higher rents as well.
--Extremely low interest rates have also encouraged major countries around the globe to pursue deficit spending policies, from the central government level on down to local municipal levels. The result is that many major countries (and Belgium too, apparently, no idea why it is on this chart) have never been more levered. That particular version of this chart shows the US as less leveraged than it was after the financial crisis, but I am not sure that is true.
--But governments are not the only entities that have had an increased appetite for debt while it has been cheap. Corporations around the world have also gorged on debt. Large US corporations (as exemplified by the S&P 500) have never been more leveraged. (Note: EBITDA stands for Earnings Before Interest, Taxes, Depreciation & Amortization, a crude measure of available cash flow for debt service). The US corporate sector as a whole has never had more debt, relative to the size of the economy. Many of these companies have been issuing debt in order to fund stock buy-backs. Financial theory suggests that is the right thing to do, but there are some pretty big real world caveats. One is that if doing so increases risk of insolvency meaningfully, it is probably a pretty bad idea. The second is if they are borrowing money to buy back shares that are grossly overvalued, that tends to be a pretty bad trade over time.
--One relative bright spot, is that US households aren't quite as indebted as they have been in the past, even if they are deeply in debt relative to a longer history. As bright spots go, that isn't too terribly reassuring.
So a decade or so of Central Bank policy has led to an increasing wealth and income disparity and has also led to there being a lot more debt outstanding than there was heading into the 2008 financial crisis. And the compression in rates and yield spreads has also benefited asset speculators and aggressive investors at the expense of savers and conservative investors. The low absolute rates also likely caused many investors (and I don't just mean individuals here, I am talking institutional investors) to accept levels of credit risk in their portfolios that they would have otherwise shunned, because they had to seek some kind of yield.
Now, after years of Bernanke and Yellin, we have a hawkish Fed chairman and a President that is pushing an inflationary agenda (increased deficit spending and protectionism both being inflationary). There are signs of accelerating inflation that are starting to perk up and the FOMC (Fed Open Market Committee) is now expected to boost the Fed Funds rate significantly this year. Bond investors are starting to get nervous and some long-time bond bulls have declared that the multi-decade bull market is over. (That means they expect bond prices to go down, which means yields go up. The market yields on longer term government bonds are what set longer term interest rates, not the Fed.)
This isn't 2007/2008, because while there are lots of warnings signs that long term imbalances need to be resolved, there isn't a clear path to total disaster like there was at that time (the housing market and subprime mortgage debt). It is likely there are some nasty surprises out there lurking in the weeds, however.
One also wonders how an economy that has only barely gotten past stall speed with the assistance of massive doses of cheap debt will do when it is cut off from that performance-enhanced drug. The fact that rates on adjustable rate debt will start going up at the same time is a bit of a double whammy on that front.
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