Tuesday, September 10, 2013

Minsky's Moment

I am watching the stock market tick ever higher while at the same time watching the cost of money aka. interest rates tick ever higher. Something is going to break.

The Minsky Moment arrives when the marginal borrower is no longer able to refinance their debts, setting up a chain reaction of higher interest rates and defaults across all marginal borrowers...

With a "Recovery" Like This, Who The Hell Needs Recessions...
I just read this article stating that private debt levels have not come down much at all in the past 5 years. As of last year, the debt to GDP ratio is still a historically massive 163%.  As the article states, the only time U.S. debt levels were this high was right before the Great Depression in 1929, and right before the financial collapse, in 2008. Given that the weak and ephemeral GDP "growth" the U.S. is experiencing now is solely dependent upon ongoing government debt accumulation, only a fool assumes that this time will be different. Speaking of the 1920s, U.S. income inequality is now at a record high going back all the way to 1927! The robber barons of that era have nothing on the overpaid dilettante billionaires of today whose wealth is at an all time high, owing to their effortless wealth generation machine i.e. Central Bank money printing and industrial arbitrage aka. outsourcing. The past five year economic "recovery" was merely a massive lie propagated by wealthy elitists and their sycophantic bukkake whores in government and the media. With a "recovery" like this, who the hell needs recessions. Another five years of "recovering" and we will be living in the early 1800s.

Wall Street's "Little" Mistake, Buried the Grandchildren
Speaking of time travel, incomes went in one direction and public debts went in the other direction. Whereas private debt may be roughly the same as five years ago, U.S. public debt is far higher. It took 229 years, from the founding of the country until 2005, for U.S. Federal debt to reach the $7.75 trillion mark (which by coincidence is roughly half of GDP).  In just seven years since that date, the debt doubled again to $16 trillion. The U.S. debt has been rising at a 9% annual compound rate for 33 years i.e. since Reagan. 


Who Blinks First?
Of course, the increase in interest rates affects all borrowers, not just the U.S. government. I've explained a dozen times why I assume the U.S. will not be the first domino to fall, so I will spare that discussion except to say that the factors involved include - risk free rate/capital asset pricing, derivative collateralization, reverse flight-to-safety/carry-trade repatriation, quantitative easing, reserve currency status - almost all factors unique to the U.S. The U.S. is the only country in the history of the world - that I know of - whose interest rates went down after a debt downgrade (i.e. 2011). I don't presume this "special status" will continue indefinitely only that in the sequence of things, a U.S. Federal Government default will be closer to the end than the beginning. So assuming the rise in rates continues, we will soon find out who is the least solvent and therefore most likely to kick-off the Minsky Moment - developed world governments, emerging market governments, municipalities and cities, overleveraged housing markets etc. The five year orgy of low interest rates has incentivized all constituents to leverage up with as much debt as possible, under the assumption that debt carrying costs would remain low indefinitely. Unfortunately, debt carrying costs don't just consist of interest rates which are now rising. Maximum leverage implies minimum equity, so in that situation, the real debt carrying cost becomes the principal not the interest. When equity is razor thin, the ability to refinance/roll-over principal is purely a function of asset values aka. collateral. Therefore, borrowers face the prospect of being squeezed from two sides - higher interest rates and potentially stagnant or lower asset values. Once asset values plateau and then decline, rolling over existing debts becomes ever-more difficult on the way to becoming impossible. Meanwhile higher interest rates themselves end bull markets in asset values as the marginal buyer can no longer afford the higher asset prices in conjunction with the higher borrowing costs. So higher asset prices combined with higher interest rates are a deadly self-destructing combination, having only caused every major asset crash in the past 100 years (and likely all others prior).

Monetary "Tapering" is De Facto
Ten Year Treasury Yields (interest rates) and S&P (black line):


Real Estate (Investment Trusts)
Already tapered...