The Message From The Debt Markets: Get Your Money Now!

by: John M. Mason

Monday marked the third biggest day for investment grade bond issues in the United States on record going back to 1995.

There were also a substantial number of deals that hit the markets in Europe as well.

The Financial Times reported that around $21 billion of bonds were issued in the United States, while almost €8 billion more debt was issued in Europe. Last week, "High grade borrowers sold $29 billion in four days…" reports The Wall Street Journal.

One argument for this rush to market was that Monday was rather "peaceful." Last week was relatively tumultuous, with the U.S. stock market hitting near-term highs. And on Wednesday and Thursday of this week, there will be a meeting of the Open Market Committee of the Board of Governors of the Federal Reserve System.

No one knows what the result of that meeting will be, and no one knows how the financial markets will react to whatever it is that the Federal Reserve System decides to do.

Short-term interest rates are near zero and long-term bond rates or at or near all time lows.

It seems to be a good time to lock in some of these low, low interest rates, as we just don't know what is going to happen to interest rates in the near future.

What will these corporations do with the money? Well, they can pay off old debt issues and reduce their interest costs. They can buy back their stock. They can hoard the cash for use in mergers and acquisitions at some later date when the inflation rate starts to pick up. The can speculate in commodities.

Holding cash right now is not a bad thing. It is so cheap, and one can possibly find some very good uses for it in the next year or so.

Furthermore, the corporate hoarding of cash has been going on for quite some time now. Over the past year or so, even Microsoft issued some long-term debt for the first time in its history. Now, go figure that out!

"Everyone should be coming to market right now," said Ken Naehu, head of fixed income at Bel Air Investment Advisors, as reported in The Wall Street Journal article linked above.

And everyone that can seemingly is. From the Financial Times article linked above:

Yesterday's sales have pushed the total for U.S. investment-grade issuance to nearly $50 billion so far this month -- the best start to a month since March -- and comes after the busiest August on record for global debt sales. More than $130 billion of corporate bonds were sold last month, according to Dealogic -- the best August figure since it records began in 1995.

This is the world the Federal Reserve and the ECB have created.

And the front page article in The New York Times today cries "As Low Rates Depress Savers, Governments Reap the Benefits." The article cites the retiree who says that he might as well keep his money in a mattress. That way, he is losing no interest on the money, and he can see the cash whenever he wants to check whether or not it is there.

And people worry about the fact that the income distribution is so skewed toward the wealthy in this country. What we are experiencing today is just the continuation of all the credit inflation that has been created by the United States government over the past 50 years. The wealthy prosper, the less wealthy suffer. The beat goes on.

The thing is that the current efforts of the Federal Reserve System and the ECB are creating a situation that we are going to have to live with for years. And the situation is just going to get worse once the banking system starts lending from the large hoards of cash they are now sitting on. It is not just the hoards of cash the large corporation are hoarding.

What a lot of people, including economists, don't seem to understand is that when these funds are finally used or spent, the funds don't have to go into productive outlets.

The general assumption is that once the banks start lending again and once the large corporations start spending again, investment spending will pick up, people will be employed once again, and economic growth will really start to expand again. Then, everything will be all right.

However, if a corporation buys back its stock, that doesn't create new output. If a corporation acquires another company, that doesn't create new output. In fact, as the acquirer reorganizes the firm it acquired and lays off people and reduces the size of the physical operation, the new organization created in the merger may actually reduce the amount of output that is produced instead of increasing it.

If the banks lend to businesses doing these things, or lend to people who speculate in the commodities markets. or to people who take the money offshore because interest rates are higher elsewhere, these dollars will not go into increasing productive output.

The point is that the creation of debt does not have to result in an increase in economic growth. It can just go into prices.

And, who does this benefit?

It does not benefit the worker who is waiting to be re-employed in the job he was laid off from before during the recent economic recession.

The credit creation does benefit those that can use the expansion of debt to exploit the new opportunities created by the way the next wave of inflation is going to play out. The new inflation is not necessarily going to be centered in consumer prices or producer prices.

The new inflation will be in asset values. both financial and non-financial. I believe we just saw the tip of the iceberg in this kind of inflation in the latter part of the 1990s and through the 2000s. This is a kind of inflation that will be reinforced by financial innovation, the kinds of financial innovation that evolved over the past 20 years or more.

The buildup in cash balances by issuing large amounts of debt while interest rates are so low is just an early stage in the coming, next big thing.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any 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.