Record For Junk: Love The Low Interest Rates

Summary

• New records are being hit every day when it comes to the issuance of junk debt, and a lot of these funds are going to pay for higher dividends.
• Now, however, we are facing a time when the low interest rates and the availability of money may be coming to an end which raises a lot of concerns.
• But, acting in a way that will raise interest rates and reduce credit flows will disrupt markets that have been, almost continuously, supplied money to support economic growth.
• The problem is that these efforts to stimulate the economy have resulted in numerous distortions in the financial markets that cannot be resolved by even more stimulus.
• This is the dilemma that policy-makers and investors face when looking at where interest rates are going to go and what is going to happen to the stock market.

Natali_Mis/iStock via Getty Images

Debt fills the United States economy. And, there is no indication of a slowdown.

Low interest rates, to many, are seen as a real blessing,

"U.S. companies have sold a record amount of junk-rated loans to raise money for dividends this year."

So writes Sebastian Pellejero in the Wall Street Journal.

"Nonfinancial companies...have issued more than $72 billion worth of speculative-grade loans to pay dividends in 2021 according to S&P Global Market Intelligence's LCD."

"That is already a full-year record in data going back to 2000, topping 2013's previous high of $54.4 billion."

"U.S companies have also issued a record amount of junk bonds, while leveraged loan sales are on a pace to surpass 2017's record of $503 billion."

Dividends go up. Stock prices go up. And, everyone is happy.

This is a picture of what the financial world in the United States looks like these days.

But, it is just one part of an economy that is almost overwhelmed with liquidity through central bank money creation and an amazing amount of debt creation almost everywhere you look. It is a picture I have tried to fill out in numerous posts about the various current happenings throughout the financial community.

A Long-time Coming

I have also argued that where we are now took a long time to get here and is not something that has just happened overnight.

In fact, the current situation is a result of economic policy discussions that go back into the 1960s. Its foundation comes from Keynesian macroeconomic thinking, something that produced something called "the Phillips Curve."

The Phillips Curve was a statistical relationship that seemed to indicate that the government could achieve lower rates of employment if the economic policy could generate a slightly higher rate of inflation.

The concept of the Phillips Curve became embedded in economic policy-making for the rest of the 20th century. And, Republican administrations relied on it just as much as Democratic administrations. Politicians feasted on the possibility that they could achieve lower unemployment rates which would lead to their re-election.

But, there was a second major contributor to the current situation. Ben Bernanke, when he was the Federal Reserve Chairman argued that economic research showed that if consumer wealth rose, consumers would spend more and so continually rising consumer wealth would be conducive to higher economic growth rates and longer periods of economic expansion,

The major component of consumer wealth was the stock market.

And, Mr. Bernanke's program succeeded and it was continued on by those who followed him, Janet Yellen and Jerome Powell.

This is the background for the current situation we now find ourselves in. It took a long time to get here and will take time to be reversed.

Credit Inflation

What results from this kind of continuous stimulation?

Rana Foroohar writes about the result in the Financial Times.

Policies, like those applying the Phillips Curve, end up, according to Ms. Foroohar, encouraging "speculation and debt bubbles."

In other words, government stimulus packages were aimed at generating physical output and creating jobs.

What happened was that the stimulus monies went into assets: houses, gold, stocks, and other "stores of value."

This result is what I have called "credit inflation." Government policies that create increases in asset prices, but not in consumer prices.

And, the last big battle against consumer price inflation came when Fed Chairman Paul Volcker fought against the government's inflationary policies in the early 1980s. Ever since his success at that time, the economy faced more and more bouts of credit inflation than it did consumer price inflation,

Even when Fed Chair Bernanke was generating lots of credit inflation, consumer price inflation was only rising at a compound rate of around 2.1 percent for the full time of the economic recovery following the Great Recession.

Going Forward

Ms. Foroohar, however, presents us with the dilemma we are now facing,

"The real problem here is that we have left it too late to normalize monetary policy and create a more balanced economy that isn't just about riding asset bubbles."

Right now, the U.S. economy is greatly distorted.

Money is floating around everywhere. Debt is being created all over the place, not just in terms of Junk loans or junk bonds. There are blank check companies (SPACs), there are private asset management firms and angel finance groups financing companies. Venture capital is going strong. Mergers and acquisitions are plentiful. And so on and so forth.

And, then there is the ugly head of consumer price inflation raising its head.

Although Mr. Powell and others at the Federal Reserve are contending that the current rise in the inflation numbers are due to supply chain problems and the difficulties still resulting from the spread of the Delta version of the Covid-19 pandemic, there is a rising concern that "actual" inflation might, in fact, really be rising at unacceptable rates.

This is one thing we won't really know until it happens.

Sophisticated investors have learned over the past fifty years or so, that credit inflation takes place within the asset community. If this focus continues to predominate, then we will continue to get, as Ms. Foroohar suggests "speculation and debt bubbles."

However, with all the money lying around, we might find, at this time around, that more of the stimulus money may go into the production circuit rather than into the financial circuit. This would result more in the "real" inflation that Mr. Powell and others are now worried about.

If we get greater amounts of "real" inflation, the Federal Reserve will be faced more with the need to begin to taper the amount of securities that it purchases every month.

And, then you get the outcome that James Mackintosh, writing in the Wall Street Journal, suggests.

Mr. Mackintosh is worried that the inflation and the Federal Reserve could cause higher bond yields. And, if we get higher bond yields because the Fed is tightening up, investors in the stock market have a right "to be Spooked."

Bottom Line

The U.S. economy has come a long way.

Over the past two years or so, we have seen an acceleration in financial markets that has been placed on top of the credit inflation that has driven assets prices and the economy for over fifty years.

The distortions that now exist in the financial markets and in the economy are not going to be worked out easily, especially with the habits that have been developed during this period of credit inflation.

And, this is the difficult thing. Breaking habits is hard to do. But, just how much further can the Federal Reserve and the federal government go in continually inflating the economy with lower interest rates and more and more government spending?

For one, contrary to what a lot of people think, credit inflation does not seem to help the people it aims to help over the longer run. More and more research is showing that credit inflation actually results in greater income/wealth inequality and that the governmental efforts of the past sixty years have played a big part in what has happened in the U.S. when it comes to this particular distortion of equality.

The junk-loan picture puts this into perspective.

Companies raise money by selling junk loans. They use the money to pay dividends. Stock prices go up. Stockholders are happy because their wealth goes up. And, note, the top 10 percent of the population in the U.S. owns 84 percent of equities.

How long can this go on?

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[thumb.ai]

Thanks especially for the links

[StevenK1]

When we are done with this inflationary bout, and action is taken, it will be found out that owning equities or bonds was the wrong bucket.

Holding Cash was the correct non-obvious answer.