By MN Gordon
Approaching a Tipping Point
Taking the path of least resistance doesn’t always lead to places worth going. In fact, it often leads to places that are better to avoid. Repeatedly skipping work to sleep in and living off credit cards will eventually lead to the poorhouse.
Sometimes the path of least resistance turns out to be problematic
The same holds true for monetary policy. In particular, cheap credit policies that favor short-term expediency have the effect of layering society up with an abundance of long-term mistakes. Artificially suppressed interest rates via central bank asset purchase schemes are not without consequences.
What’s more, once set in motion these consequences don’t stop until they’ve fully run their course. The booms of plentiful credit must always be followed by the busts of unserviceable debt. As more and more debt drifts into arrears the debt structure breaks down. Yet when the actual tipping point is crossed is often unclear until after the fact.
Quantitative easing “officially” ended over two years ago. The interim period has been relatively sanguine; asset prices have continued to inflate. But lurking around the corner is the inevitable downside of quantitative easing.
As we’ve seen, the downside’s onset has taken years to manifest. Nonetheless, credit markets are now signaling a breakdown. Moreover, we expect these signals to grow ever louder as the year progresses.
The Insanity of the Echo Bubble
In a recent article titled LIBOR Pains, Pater Tenebrarum succinctly describes the nature of the problem:
“There are several points worth noting in this context:
corporate debt relative to assets is back at a record high (last seen at the peak of the late 1990s mania);
US corporations are spending far more than they are taking in, i.e., the sum of capex, investment, dividends and stock buybacks vastly exceeds their gross cash flows – the gap is in fact at a record high, above the previous record set in 2007.
the return on equity of US corporations is at a record low (yes, you read that right!).”
A chart we didn’t show in the above mentioned article: the debt-to-asset ratio of non-financial corporations. It is now finally back at the level that prevailed at a point in history which in hindsight is widely recognized as a time of almost unparalleled collective insanity. It is less obvious today in some ways, mainly because it has migrated from retail traders to institutions. Institutional insanity is less conspicuous, but it may be even more dangerous for that – click to enlarge.
Obviously, the palette of high debt, low profitability, and low return on equity paints a grim picture of things to come. So how did corporate officers manage to paint themselves into such a tight corner?
In short, false signals from the Fed’s cheap credit compelled them to make decisions that otherwise wouldn’t have made good business sense. An abundance of debt was taken on to make business investments that have not panned out. Financial engineering has also exacerbated the mistakes.
The big banks packaged their corporate loans into collateralized loan obligations and passed them …read more
Source:: Acting Man
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