We’ve been reporting on the work of Richard Duncan, who is currently chief economist at Blackhorse Asset Management in Singapore.
We went down the road with him, from the causes of the stock market boom to the inevitable bust…thence to the US Federal Reserve’s inevitable reaction and to another leg up in the stock market. But here is where we part company.
Duncan believes a credit deflation would be devastating. We have come to rely so heavily on credit from the Fed, he says, that taking it away would mean chaos, depression and war.
‘In all probability, our civilisation would not survive it,’ he concludes. Faced with such a calamity he believes there is no way to go back to the sound principles of 19th century banking and finance. Instead, we have no choice but to go ahead.
But to where? And how?
Hold on. One question at a time, please.
To where? Japan!
How? By using the same policy tools the Japanese used. It worked there, didn’t it?
The US Federal Reserve is fully committed to staying the course. If credit deflation returns to the US, it will have to be over Janet Yellen’s dead body. Which is not a bad idea. But Yellen is not likely to let it happen…not if she can prevent it.
But there’s the rub. If credit is going to keep expanding, someone has to borrow more — a lot more.
Household debt topped out in 2007. With total US household debt at more than 600% of disposable income, and mortgage debt far out of proportion to rents, households were tapped out. They had spent so much in the past they had nothing left for the future.
Since then, US households have managed to reduce their debt levels, although the last few months they have started to borrow again. In any case, they won’t be able to borrow much…because they don’t have the disposable income to support it. And there is no sign that incomes will increase substantially.
If households can’t continue to add debt, who can?
Next in line is the corporate sector. Corporations have been doing a manly job of borrowing lately. As if to show that the guys who get the big bucks are no smarter than anyone else, they are borrowing money on an epic scale largely to buy their own shares at record prices. That’s right: Buy high! At least it helps raise the bonuses.
But there can’t be much more of that juice in the lemon, either. The Street’s consensus for S&P 500 earnings growth for Q1 has gone from 4.4% year over year in early January to -0.4% today. Like a household’s disposable income, lower corporate earnings leave the sector with less money to pay finance charges.
That leaves government. Bless their greedy little hearts, politicians can be relied upon to do the worst thing at the worst possible moment.
What is the worst thing a highly indebted government can do? That’s right, borrow more. When is the worst time to do it? When there is no real reason to do so — when there is no national emergency that makes it necessary. In the Second World War borrowing was an emergency. Today, it is an imbecility.
We could add an additional question: What is the worst possible way for a government to borrow money? It is to borrow it from the central bank, which merely prints up the cash on request.
That is what the US government will do. More or less like the Japanese. That is what we expect. It is also what Richard Duncan expects. But he thinks it is something the feds must do…to avoid the collapse of civilisation.
After all, the Japanese government has about twice as much debt to GDP as the US federal government. That gives the US lots of room to add debt. And that is where we part company with Duncan…
A financial system that makes bankers, speculators and Washington insiders rich…while everyone else gets poorer and more heavily laden with debt…is not worth saving.
The sooner we have shucked it off, the better off we will be.
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