“Bankruptcy happens gradually, then suddenly,” Ernest Hemingway
All signs point in the same direction. We are heading toward another financial crisis and, this time, it will likely be much worse than 2008. There is a growing chorus of economists and analysts who have already sounded the alarm, but most tend to wrap their warnings in mind-numbing statistical detail. In the following article, I aim to outline where we are — and how we got here — in a simplified manner, with the hope that you can prepare yourself as best you can.
In the early 2000s, I wrote several articles warning investors about skyrocketing deficits, debt, overvalued stock markets, and dangerous policy decisions by government and the Federal Reserve. As we all know, by 2008, a lot of what I was afraid would happen, happened. When the crash came, I further predicted we would not go into a depression quite yet, for one simple reason: The Fed would print a lot of new money (quantitative easing), which would act as a floor for the entire financial system. I warned we would pay the price down the road because there is no such thing as a free lunch. Or, as The Eagles song says: “Every form of refuge has its price.”
‘One should never underestimate the power of greed’
However, what I did not predict was which road would lead us to perdition — namely that the “easy” monetary policy of near-zero interest rates and quantitative easing would fuel a global debt bomb and stock market frenzy that is currently magnitudes larger than the level of debt that triggered the subprime mortgage crisis of 2008. To me, it seemed that given that near-death experience, it would be unfathomable for policy-makers to allow the financial sector to not only continue piling up debt, but to do so at a breath-taking pace. I guess one should never underestimate the power of greed.
So, here is how it played out in simple terms: When the 2008 crisis unfolded, the US government and the Federal Reserve bailed out the financial sector to prevent the entire system from imploding. To achieve this, they took interest rates to zero, printed $3.5 trillion of new money and ran up the fiscal deficits with an initial $700-billion bailout. However, instead of bailing out Joe Average on Main Street, all that new and “free” money was only made available to those who already had money and coveted more: Wall Street (which caused the problem in the first place), corporate America, the One Percent, and the US government. There is nothing like the offer of “free” money to make moral hazard popular, especially on Wall Street. In economics, moral hazard occurs when someone increases their exposure to risk when that risk is insured, especially when a person takes on additional risk because someone else bears the cost of that risk. In this case, that someone was the government, and ultimately, the taxpayer.
Global debt has nearly doubled since 2008
We live in an environment where risk is not only encouraged, but where investors believe they have policy-makers as a back-stop to protect them in the event of a crash. They feel they can count on being rescued by the same failed policies that bailed them out in 2008. This blind greed is what has led us to the current insane levels of debt. All categories of debt have gone through the roof. Global debt — government, corporate, household and financial — has nearly doubled to $247 trillion since 2008. That is debt that will never be paid back. Ever. In the US alone, federal government debt now stands at $21 trillion. It was $8 trillion in 2006, which I thought was dangerous back then.
It boggles my mind that every year since 2008, policy-makers and Wall Street economists have been talking about normalizing rates — getting them to a Fed rate of five or six per cent — with a straight face. How will anyone be able to service, let alone pay back this pile of debt with “normal” interest rates? They can’t. This is the same box Japan has been in for the past 30 years, since its own financial crisis. If Japan allowed normal interest rates, the country would be bankrupt.
And it’s not only the US that’s sitting on a time bomb. China has a big problem, too. Its $34-trillion pile of public and private debt is an explosive threat to the global economy. By one estimate, China’s borrowing has quadrupled in seven years. To a lesser — but equally dangerous — extent, many other major countries face similar issues with debt, including Italy. Why should we care about China and Italy? Our global financial system is such that a financial accident in one location can easily set off a series of events that jeopardizes the entire system. Think back to the role tiny Iceland played at the beginning of the last unraveling in 2007. Contagion spreads quickly in our interconnected global financial system.
Source: Frank Giustra
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