Crisis Progress Report (8): Acceleration, by Robert Gore

Debt deflations and depressions are preceded by years, usually decades, of debt build up. Growth rates of indebtedness exceed the underlying economic growth rate, increasing debt’s claim on assets and production. Debt reaches a point where the economy can no longer support the interest and repayment burden—peak debt. Slowly at first, and usually limited to one sector of the economy, debt formation and asset price appreciation go into reverse. SLL first identified this initial reversal last December, in the oil patch (see “Oil Ushers in the Depression,” SLL, 12/1/14), similar to the financial crisis of 2008’s reversal in housing and mortgage debt. Now, just like then, most mainstream economists are assuring us that the problems will remain contained. The assurances betray ignorance about the negative marginal returns on debt in a debt saturated world economy, and the complex interlinkages across debt, asset, and derivative markets that can turn a seemingly limited debt problem into a global financial crisis.

Greece has defaulted on a loan from the International Monetary Fund (IMF). Puerto Rico’s governor has said the government and related public entities cannot pay their debts. The margin-fueled Chinese stock market has reminded investors that markets can go down—hard—and China is trying to pull back from years of debt-funded housing and infrastructure malinvestment. Just as in the 2008 crisis, the financial stress points are increasing. If it has not already been reached, the point of inflection is near.

Every unraveling strand in this tapestry is woven in with many others, which in turn unravel. Regardless of how the Greek situation resolves, Greece cannot repay all its debts on their present terms. Most of the losses will be borne by the constituent nations of the IMF (including the US), the governments of the EU, and the European Central Bank. The losses will undoubtedly be “socialized,” in other words, paid for by taxpayers. Even if they are just added to the debt pile, with debt’s current negative marginal return, more debt will be economically and financially contractive, in Europe and beyond. The prices of Puerto Rico’s municipal bonds, and the share prices of US companies that have provided guarantees for some of those bonds, have plummeted. Direct and indirect owners (through mutual funds) of Puerto Rico bonds and municipal bond insurer stocks have sustained losses, which impairs their ability to spend, invest, or pay back their creditors. China’s attempt to throttle back margin and other debt will reduce both the price of financial assets and its economic growth rate. Profits and growth in many other countries are dependent on Chinese growth.

The point of inflection is the lift off where debt induced contraction and financial stress generate uncontainable and unstoppable momentum and the financial crisis greatly accelerates. The vortex of the 2008 crisis was housing and mortgage finance. The vortex of this one is sovereign credit, which will make it much more severe. Governments, aided by their central banks, picked up much of the tab for the 2008 crisis, and their debt loads have increased since then. Central banks have monetized much of that debt and have kept its cost to governments down by suppressing interest rates. The notion that expanding debt and central bank machinations could keep economies afloat was always specious. Now those nostrums have been exhausted, so governments and central banks can’t staunch the coming global margin call with hastily conceived rescues and other chimeric Hail Marys.

Monday’s turmoil was a preview, both in terms of disclosures of financial problems and their effects on financial markets. Debt contraction will act as an increasingly strong undertow on economic activity, now anemic, soon to be contracting. Look for an acceleration of disclosures and a huge ramp up of financial market volatility—jaw dropping crashes and brief, shorts-crucifying rallies. The only certainly: once what is happening becomes obvious and acknowledged by all, those who never saw it coming will continue to occupy prestigious and high-paying positions, their ignorance and wayward analyses respectfully featured in leading journals, editorial pages, television, and the Internet. Meanwhile, SLL and other blogs, commentators, and websites who have seen it coming for years will labor in comparative obscurity for their loyal audiences—those who seek the truth, face facts, and reject slogans, bromides, and conventional wisdom.

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