The Grand Delusion of a Robust Economy

April 3, 2020

I find it amusing, and somewhat disheartening, every time I hear the President talk about how wonderful the economy was before the Corona Crash.  Never one to shy away from hyperbole, he has said things like “a perfect economy” or “best economy this country has ever seen”. This is a joke. The combination of Corporate tax cuts and an accommodating Federal Reserve cutting interest rates allowed corporations to borrow money to buy back their own stock. It was not economic activity that drove up stock prices, but rather the greed of corporate America driving up their own stock prices by incurring substantial debt.

This money was not used to invest in new business ventures or take risks on expanding business. The colossal amount of liquidity was redirected to greatly increase the value of the company stock via the buybacks so board members and executives could cash in their stock options for very lucrative gains.

One must remember that executive pay is tied to the company’s stock price.  CEO’s are incentivized to keep stock prices as inflated as possible, regardless of the debt they accumulate. 

Currently, for those companies listed on the stock exchanges, the corporate debt level is rapidly approaching 10 trillion dollars.  Add another 5.5 trillion dollars for smaller businesses and family businesses and debt stands at a whopping 75% of the Gross Domestic Product (GDP)!   The following is a clip from the Washington Post before the collapse...

"A decade of historically low interest rates has allowed companies to sell record amounts of bonds to investors, sending total U.S. corporate debt to nearly $10 trillion, or a record 47 percent of the overall economy….In recent weeks, the Federal Reserve, the International Monetary Fund and major institutional investors such as BlackRock and American Funds all have sounded the alarm about the mounting corporate obligations….The danger isn’t immediate. But some regulators and investors say the borrowing has gone on too long and could send financial markets plunging when the next recession hits, dealing the real economy a blow at a time when it already would be wobbling." - Washington Post

Wait...we’re not done yet… Add another 13.5 trillion dollars of personal debt, like mortgages, credit cards and student loans. As a result, we have a nation carrying an astounding 29 trillion dollars in debt!  The total debt, corporate and personal, as a percentage of GDP, is at historic highs. 

This “perfect economy” is akin to saying, “I’m doing great because I bought a new home with no money down and a new Mercedes on my credit card.” If the economy was doing so great, why are so many corporations and individuals so deep in debt?  If you are doing well, you don’t need to carry such a highly leveraged position. 

Another example of the economy not growing, but rather contracting since Trump took office is the service sector. Since 2017, the service sector has been slowly declining before falling off the cliff in what is touted as the best environment for economic growth.

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Covid-19 is the pin that popped the bubble. The bubble was created by poor monetary and fiscal policy.  The economy was stretched and overrun with debt waiting for something to come along and pop it. In this time of need, where all Americans need relief, the Federal Reserve is out of ammunition. The Fed can provide maybe 2 or 3 months of "helicopter money", but not much beyond that. If this pandemic extends beyond the end of this year the only way out appears to be a Reorganization of / Default on the Debt.

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