It’s About Time Someone Crashed The Economy

Traders Becoming Complacent As Markets Continue to Rally Into 2018.

Depiction of the 2008 financial crisis. Picture adopted from: Review of Finance, 2017, 77-108 with Sandy Lai.
Depiction of the 2008 financial crisis. Picture adopted from: Review of Finance, 2017, 77-108 with Sandy Lai.

The S&P is at an all time high. Real Estate demand is surging in many markets across the U.S. There are bubbles everywhere. From Atherton in California to Manhattan in New York, people are buying everything. Stocks, bonds, Real Estate and let’s not forget Crypto… While there is nothing wrong with buying stocks, bonds, Real Estate (even when overpriced), or even crypto, there is something wrong with the way we are doing it.

For some time now people have been buying stocks with a P/E ratio of 340 (Amazon) without regard for the metric. Some of us have even gotten comfortable with buying junk bonds (Tesla). Others have completely abolished risk and are buying virtual coins for thousands of dollars, even if those coins have no real value. It seems as if there is no end to the madness. People will buy anything these days. You could through your money anywhere and expect good returns by year’s end, there is nothing to worry about, right?!

WRONG! There is plenty to worry about!

First things first, do you really expect the S&P to continue climbing higher even after 9 years of full throttle? If so, what is your reasoning? Aside from nine years of quantitative easing, what reasons could you give? Sure, some companies have produced tremendous returns for their investors, but many others have not. It seems that the market has reached a level of complacency where there isn’t any need to assess risk. A sort of assurance that there is nothing to worry about.

First Issue: U.S. National Debt

The U.S. debt to gross domestic product stands at 104%. That amounts to 20.245 trillion dollars of debt, which is insane when you consider that the annual interest on that amount is nearly the size of Saudi Arabia’s GDP. And to make things even worse, we have a Commander in Chief that could not be less qualified to deal with this debt (let’s just hope he doesn’t invoke chapter 11).

Second Issue: Income Inequality

Income inequality is probably the most destabilizing issue in economics today. For those of us that are deficient on the subject, its easy to ignore the impacts. Just think of how Donald Trump got elected or why right-wing populism is on the rise in the west. Even if you set all that aside, you still have to deal with the economic impacts. Studies show that high income inequality diminishes economic growth (eventually), and this effect is persistent implying that increasing inequality has a negative long-term effect on economic growth.

Third Issue: U.S. Borrowing Will Balloon Further

In order to finance an expanding budget deficit and pay for the recently enacted tax cuts, the Trump administration will be looking to borrow more than ever before. You would think that the U.S. government would want to raise its income before borrowing more, but this is not the case. It is estimated that by the end of his presidency (hopefully in 2020), Trump would have added another $3 trillion dollars to the national debt. If he manages to make it into his second term, then by 2024 the U.S. debt would have ballooned to nearly $27 trillion dollars.

Fourth Issue: Chinese Corporate Debt

You see debt is an infectious disease. Like the United States, China has used debt to finance its growth. But unlike the United States, China’s corporate debt stands at a neck-braking 160 % of gross domestic product. Don’t take my word for it, just look at what Governor Zhou Xiaochuan had to say about the corporate debt.

Even Kyle Bass warned us about the Chinese corporate sector. In an interview with Bloomberg, Kyle Bass explains how China is enduring a credit crisis. Just recently, we’ve seen reports that bond defaults are ramping up in China, with locals becoming accustomed to defaults. Moreover, investors are becoming complacent. Instead of focusing on lowering risk, investors in China still focus too much on yields

In conclusion, there is too much debt. Not just in China and the United States, but across the globe. Japan for instance has a debt to gross domestic product ratio of 245%. It just so happens that the world’s three largest economies are the most indebted. One thing about being a large economy is that you become too big to fail. If any of these three economies falter, the rest of the world would be surely feel the impact.

About Alan Judi 340 Articles
Research Analyst / New York