Nope! Nothing to See Here!
Don’t worry. Nothing to see here!
That was pretty much the message Federal Reserve Chairman Jerome Powell delivered in a speech he gave at the Atlanta Federal Reserve bank conference on May 20.
Powell talked about the high levels of corporate debt. In fact, corporate leverage is at a record level of around 35% of corporate assets. But the Fed chair said it’s not really too big a cause for concern.
Although Powell acknowledged, “Business debt has clearly reached a level that should give businesses and investors reason to pause and reflect,” he said comparisons between the current corporate debt level and mortgage debt in the years leading up to the financial crisis are “not fully convincing.”
Of course, the pundits and financial experts were all saying that skyrocketing levels of mortgage debt in 2006 and 2007 were no problem too. And they weren’t — until they were. So, perhaps we should take the current reassurances with a grain or two – or maybe a spoonful – of salt.
Powell said the levels of corporate debt were in line with economic growth. He emphasized that debt service costs remain low. And he said the financial system is better able to absorb losses.
See, nothing to worry about!
“As of now, business debt does not present the kind of elevated risks to the stability of the financial system that would lead to broad harm,” Powell said.
The Fed chair did take a cautious tone at times. He said that the lack of transparency about funding sources and who ultimately holds all of the corporate debt was concerning, and he warned that an economic downturn could worsen if indebted companies began to fail.
But hey, the economy is strong! No need worrying ourselves about a downturn, right?
Of course, everybody is trying to read the tea leaves and figure out what the Fed might do based on Powell’s remarks. Reuters noted that the Fed may be reluctant to cut interest rates again because the Fed chair said another sharp increase in corporate debt “could increase vulnerabilities appreciably.” Cutting rates could encourage even more borrowing.
But what about the flip side of that coin? Rising rates would jack up the cost of servicing all of this debt. And since the economy is built on all of the borrowing the central bank encouraged over the last decade, how can the boom keep going without more borrowing?
Basically, the Fed is stuck between a concrete wall and a hard place of its own making.
Despite all of the mainstream reassurances, Jim Rickards thinks there might just be something to see here. As he explained in a recent post on the Daily Reckoning, the Fed has created a vicious cycle that it probably won’t be able to extricate itself from.
We all know the outlines of how the Fed and other central banks responded to the financial crisis in 2008. First, the Fed cut interest rates to zero and held them there for seven years. This extravaganza of zero rates, quantitative easing (QE) and money printing worked to ease the panic and prop up the financial system.”
This is precisely why the growth in business debt has outpaced GDP growth for the last decade.
But it did nothing to restore growth to its long-term trend or to improve personal income at a pace that usually occurs in an economic expansion. Now, after a 10-year expansion, policymakers are considering the implications of a new recession. There’s only one problem: Central banks have not removed the supports they put in place during the last recession.”
In other words, the economy is still hooked to the central bank life support system after more than 10 years. When the next crash comes, what is the Fed going to do? You can’t put the economy on more life support. Rickards sums it up:
In short, the Fed (and other central banks) have only partly normalized and are far from being able to cure a new recession or panic if one were to arise tomorrow. It will take years for the Fed to get interest rates and its balance sheet back to ‘normal.’ Until they do, the next recession may be impossible to get out of. The odds of avoiding a recession until the Fed normalizes are low. The problem with any kind of market manipulation (what central bankers call ‘policy’) is that there’s no way to end it without unintended and usually negative consequences. Once you start down the path of manipulation, it requires more and more manipulation to keep the game going. Finally it no longer becomes possible to turn back without crashing the system.”
But hey, Powell says there’s nothing to see here. So…
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