Poor Mans Infograph: The Feds Conundrum and Debt Trap
Economics can be a dry topic to most. Thus reading through articles and books is tiring. Hence why most individuals pay someone to do it for them.
That is why I compiled a 9 figure presentation, straight from the Feds own data, showing a brief thesis of how the Feds zero interest rates and quantitative easing programs have created severe unintended consequences with no clean way out.
Officially? The Feds original premise was to lower borrowing costs of over-leveraged (indebted) citizens and keep individuals in their homes and prevent banks from failing (a catastrophe that occurred during the 1930’s Great Depression).
Unofficially? The Fed needed to lower borrowing costs for the US treasury to borrow money, keep individuals consuming – creating the “wealth” effect by artificially raising asset prices, and most importantly – depreciate the value of the US dollar to make exports more competitive abroad i.e. currency war.
“The Fed front-loaded an enormous market rally in order to create a wealth effect … we [The Fed] injected cocaine and heroin into the system [quantitative easing + zero interest rate policy] … now we are maintaining it with ritalin.” – Former Dallas Fed President, Dick Fisher.
As a side note: it is ironic, isn’t it, that the economy is in this mess from too much debt – and yet the global elites solution? More debt.
The global treasurers, financial ministers, central bankers, and IMF (International Monetary Fund) directors seem to be stumped on what to do next.
In fact, isn’t it the whole point of these Harvard, Yale, Ivy League graduates with PhD’s and distinguished academics to understand such complex markets and make the prudent decisions required to better their respective countries living standard and protect ourselves from such ‘black swan’ events? Yet, all they seem to prescribe is more debt, more spending, more money printing, and more bailouts.
Does one need to have a PhD for such prescription? Makes me wonder.
Moving forward, the following is the Poor Mans Infograph, which shows readers the unintended consequences of ZIRP and how it is going to end badly.
Figure 1: In 2008, due to the Second Great Depression, Ben Bernanke (then chairman of the Federal Reserve) pushed interest rates down to 0%. ZIRP (zero interest rate policy) to keep liquidity going.
Figure 2: Also to accommodate ZIRP was the QE (quantitative easing) bond buying, i.e. printing money, by the Fed.
Figure 3: As expected from lower borrowing costs coupled with cheap money and federal assurance of student loans, an enormous bubble erupted in college student debt, condemning millennials for decades of crippling payments.
Figure 4: Also thanks to ZIRP + QE, being able to finance an automobile became much more attractive from the lower interest payments and extended loan terms – putting every American with a beating pulse in a brand new financed car they could not afford.
“The low-rate environment has lowered the costs for lenders and boosted institutional demand for auto loan-backed securities, which not only brought more buyers into the market through subprime expansion but also helped them buy more expensive trucks and SUVs with extended loan terms,” says Edward Niedermeyer of The Federalist.
Figure 5: And as ZIRP was here to stay, corporations piled on dangerous amounts of debt. Investment grade and Junk Bonds were issued at low interest rates, increasing a companies EBITDA (Earnings before Interest Taxes Depreciation& Amortization) as they paid lower interest to service those debts, artificially boosting earnings.
And as yields were grounded, companies that were risky (example of the fracking and oil companies from 2009-2014) were able to get cheap financing in the Junk Bond market.
Uniformly, low rates dull the effort for investors to distinguish good investments from bad investments. And at next to nothing percentage points, one credit looks much like another – thus investors kept financing these speculative stocks.
Figure 6.1: And as those companies that benefited from cheap funding and lower rates, the good times never last forever. As oil prices plunged 75% in roughly 20 months and the Fed began tightening, the credit of the fracking companies and speculative grade companies degraded, which in turn made yields rise. Now US High Yield Junk Bonds are the highest they have been without being in a recession as the credit of the companies in the underlying stock market deteriorates.
Figure 6.2: Since Q2/2014, the most irrational disconnect has been the widening divergence between corporate Americas share prices and their credit ratings. Future economic historians will undoubtedly scratch their heads over this issue.
Figure 7: But arguably the largest benefactor of ZIRP and QE has been the US Government and its federal debt binge. The Fed was able to depreciate the yield of the US 10-year bond to subsidize the US Treasury; allowing them to borrow more at lower cost.
Figure 8: Yet as the debt burden increases, the interest payments do also. And as the Fed raises rates, the US government will owe more just to service its outstanding debts. If the US is paying roughly $450 billion when the 10-year is around 2%, it will be $900 billion at a mere 4%.
Looking back at Figure 1. rates were hovering around 5-7% for years. The US government would drown under interest on its huge federal debt amount.
Figure 9: Thus one would expect the Fed to further pick up the slack, as shown below, and buy the US governments debts i.e. monetizing the federal debt. The Fed will have to print dollars to do this. Expect this chart to keep trending higher as the Treasury turns to the Fed to help finance its growing liabilities and expenses.
Conclusion: as rates stay lower, inflation will increase over time along with more cheap debt. And if rates further rise, there will be a default (loss) cycle as the dollar strengthens and servicing the debts becomes more difficult. More importantly, as rates rise, all that outstanding debts which were financed in a low rate era – the auto loans, college loans, corporate loans, corporations, and even countries (Greece and Puerto Rico) – will have to pay higher interest payments during a global economic slowdown.
It looks as if gold bullion, an investment with 5000+ year history of use and exempt from counter party risk, is becoming more attractive.
Contrarian and Austrian - Value Investing Ideas - Anti-Government Philosophy - Author.