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Navigating the Storm: Debunking the Soft-Landing Illusion
As we delve into the intricate web of global economic challenges, we must confront a widely held yet misguided notion that often clouds our discussions: the belief in the possibility of a soft landing . Some argue that the world economy can gracefully navigate through turbulent waters, avoiding an impending storm and emerging unscathed. However, it is imperative to assert that such predictions, while comforting, are fundamentally naive as they fail to grapple with the stark reality of a worldwide debt overhang.
Challenges of a Soft Landing: The concept of a "soft landing" implies that the global economy can traverse the turbulent seas of economic imbalances, excessive debt, and structural issues without enduring a significant economic downturn. While this notion is undoubtedly attractive, it stands on shaky ground when confronted with the harsh realities of our current economic landscape. For one, the “global economy” is not some unified body, thinking and acting as one. While profit motive drives much – if not nearly all – economic action, navigating a soft landing would require unprecedented levels of international cooperation and coordination that has hitherto been unrealized.
The Reverse Multiplier Effect: In economic discussions, the concept of the "reverse multiplier effect" or the "downside of economic leverage" has emerged as a critical topic. During periods of economic growth fueled by increased money supply and leverage (ie “now”), a positive multiplier effect is observed, stimulating additional economic activity. However, if this growth is unsustainable or excessive, it can lead to adverse consequences when the economy contracts. In times of economic downturns or concerns about inflation , the reverse multiplier effect comes into play. The excessive debt and leverage that once fueled growth can amplify the negative impact on the economy. Reduced spending and investment result in economic contraction, initiating a downward spiral. We at the Puck and at CMBG see this playing out in real time in our economy. While the Chips Act and the Inflation Reduction Act are pouring billions of dollars into our economy, the monetary policy of the Federal Reserve is working to slow the economy. In this regard, fiscal policy is at odds with monetary policy and as our deficits continue to swell and as inflation continues at a pace far greater than two percent the middle-class struggles. Although, the government is stating that inflation is running at under 5%, the real effect on consumers is far worse. The government is under-reporting inflation to politically suit itself and to avoid the unsustainable increases in social security if they were to accurately reflect the true inflation effect on all our lives. And this is not a new trend. The truth is as a country we are getting poorer as we devalue our currency at an alarming rate in order to suit the investment class rather than valuing the contributions of labor, and it will unfortunately likely require a crisis to force our leaders to tell the truth and to make unpopular decisions.
Global Debt Crisis: The world currently finds itself ensnared in a web of unsustainable debt levels that have accumulated over the past two to three decades. Factors such as low-interest rates, easy access to credit, and a culture of borrowing beyond our means have all contributed to this ominous debt overhang. Consequently, nations worldwide, including economic giants such as China and Japan, now bear staggering levels of debt. These debt burdens are not mere figures on a balance sheet; they represent a ticking time bomb for the global economy. As we witness China grappling with its debt overhang, we can see that there is no easy answer, or they would have taken more dramatic action. Their youth unemployment is at staggering high levels and as such they have recently stopped reporting to the world, the actual level of unemployment as a sign of defensiveness. Exports and imports are materially down based on publicly released data and it appears that their economy has materially slowed down.
Repercussions of Excessive Debt: The repercussions of excessive debt are multifaceted and severe, encompassing financial instability, diminished economic growth, and heightened vulnerability to economic shocks, among other consequences. Given the interconnected nature of the global economy, the impact of this debt transcends national borders, reverberating across continents and affecting markets, industries, and individuals worldwide.
The most prominent of these risks is exemplified when individual investors begin to default on their financial obligations, which was ultimately the house of cards upon which the 2007 subprime mortgage crisis was built. Commercial real estate debt, apartment financing debt, cryptocurrency debt, and technology non-bank debt, although distinct, collectively contribute to the overarching issue of debt overhang, thus increasing exposure once individuals or financial institutions are no longer able to pay their bills.
Loans financing commercial properties have the potential to result in oversupply and price bubbles when excessive borrowing occurs, leading to defaults and financial instability when these bubbles burst. Loans directed towards multifamily properties can lead to oversupply and price distortions, particularly during economic downturns. These circumstances can strain property owners' ability to service their debt, especially with variable rate loans vulnerable in a recession and higher interest rate environments. Borrowing against cryptocurrencies exposes individuals and entities to risks associated with price volatility. This volatility can lead to defaults and financial instability, with the lack of regulatory oversight amplifying these risks. Non-bank lenders, including fintech startups, often rely on debt financing to fuel their growth and innovation. Many of these non-banks have borrowed from large, regulated banks, and when these non-banks fail because their borrowers start to default, it will have a ripple effect that imperils the regulated banks.
Shift to Non-Covenant Loans and Their Risks: In the realm of borrowing, the transition from covenant loans to non-covenant loans bears significant implications. Covenant loans traditionally imposed specific financial and operational requirements on borrowers, offering lenders early indicators of deteriorating financial health. Nevertheless, in today's climate characterized by abundant capital and an impression of limitless liquidity, non-covenant loans have surged in popularity, introducing challenges in identifying and addressing potential issues before they escalate.
Non-covenant loans involve reduced monitoring, featuring fewer reporting requirements. This diminishes lenders' ability to oversee a borrower's financial health and detect problems early on, thereby delaying problem identification and potentially leading to financial distress. Such loans heighten risks on various fronts, posing difficulties for borrowers seeking refinancing during economic downturns that coincide with lower interest rates. Lenders, on the other hand, face elevated risks of defaults or financial stress due to reduced visibility into the borrower's financial situation. What could go wrong? It’s not like easing borrowing requirements has ever backfired before (see again: the housing crisis ).
CMBG Advisors' Insights: At CMBG Advisors, we offer a front-row perspective on these issues as an increasing number of companies succumb to the weight of excessive debt and inadequate earnings. The relentless emphasis on revenue at the expense of profit is now coming home to roost, ushering in a wave of corporate collapses that further exacerbates the global economic challenges we confront.
The United States, with its unique status as the world's primary reserve currency, has thus far managed to postpone the immediate consequences of its debt. However, this delay should not foster a false sense of security. The day will come when the piper must be paid, and the U.S. may not be immune to the long-term economic repercussions of its fiscal choices. It's essential to remember that the U.S. has injected liquidity into the economy through both fiscal and monetary policy, enabling both corporations and individuals to recklessly accumulate excessive debt.
Putting all this together and applying the laws of physics, what goes up must come down. It has happened before, and it will happen again. The world is going to learn the lesson of too much debt the hard way. It will be exceedingly painful. The storm is coming. It has started to arrive. It is a hurricane and like any hurricane is comes at its own speed and we never know until afterwards who will ultimately affected. But we do know one thing, there will be destruction, there will be winners and losers, but the world will be affected in more material ways than in 2008 because we didn’t solve the challenges of the day back then and with prolonging the spending party, the clean-up will be that much worse. CATCH UP ON PAST EPISODES https://podcasts.apple.com/us/podcast/episode-65-neil-degrasse-tyson/id1338978270?i=1000625480261