Sep

5

my birthdayThe more I think about it, I don't believe credit and debt are likely to be our biggest issues in the next couple of decades. The credit crisis was really all about the valuation of illiquid assets, and the death-spiral of marking to market assets that stopped trading outright, because no-one knew what to mark them to, and therefore couldn't assess counter-party risk. It struck me early on in the crisis that trying to mark these "assets" to market was stupid. The most obvious solution was to take troubled debt, garbage or otherwise, and refinance it over longer maturities to gain some breathing room. And that's kind of what happened, and here we are today with LIBOR nicely back to normal. If things get really bad again, central banks will just lead re-financings like the Europeans did earlier this year - and keep interest rates low, because sizeable tranches of new money will likely have to be created from time to time.

Interest rates have to stay low now because governments are running large deficits and adding to their already big piles of debt, and can't really afford to pay much higher interest. The cost of credit appears to have shifted toward a subsidy regime much like agriculture, and could very well become as politicized. Credit needs to be cheap and affordable, and kept there as everyone - governments, business, and consumers - get used to paying so little for money. Because the U.S., Europe and Japan are all in the same boat (Japan saved us seats) and represent the currencies where most reserves are parked, I think we're going to see low interest rates for a long time - even if economic growth comes back, which it should as everyone continues to refinance longer-term debts to lower rates. They'll be able to keep rates low because there really won't be any other game in town currency-wise.

This is my assessment, and who knows if it really will play out that way, but if it does, I think the current financial system and major economies can remain intact for a long, long, time, deferring the day when debt really comes home to roost. I foresee a more robust form of what Japan has gone through in the last couple of decades. Not as much growth as before, a lot of bad debt in the attic that no-one wants to write down in a big hurry, but generally better economic performance than Japan in the aggregate. The analogy I would make is the stretched family that just keeps paying off one credit card with another indefinitely. I think this will be our macro fiscal situation for a while.

Most things in the world will still function, so commodity and equity markets should return to business as usual– they pretty-much have already. With such low interest rates, not sure what's going to go on in the bond markets. When confidence increases, a lot of that money may actually shift to equities and commodities for higher returns, and with that appetite, it might soon again be a good environment for IPO's to absorb some of that capital, and the innovation that goes with that. Industries that depend on, or prosper from low interest rates should do well. Real estate and utilities might boom. Deflationary pressures may still hover near, especially if consumers remain strapped for an extended period of time in the major economies.

Inflation? Don't see it here unless low rates set off another major boom. Future crises? Probably currency, in places like Russia and Brazil. Because other economies/currencies don't have the same low-interest luxury and will be more sensitive to inflation (interest rates in Brazil look to be about 11% these days), we may get some currency devaluations. War and geo-politics are always wild cards. Dollar, Euro and Yen could stay relatively strong from the influence of carry trades (borrowing cheaply in these currencies to get higher returns elsewhere).

Any thoughts out there on this and other scenarios?

Jeff Rollert writes: 

I differ… the crisis began as a liquidity crisis, and has morphed into a problem of insufficient systematic equity. Low rates are a prayer that hopefully buys enough time for debt amortization to effect a re-equitization.

Problem is it assumes stable GDP here and abroad.

Ralph Vince writes:

The villains in the story are the quants– those whose maladroit ir math  mispriced the CDOs and CMOs grotesquely– then ducked back into their dusky shadows.

Not a one of them has been called to account. 


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