The United States economy is currently faced with a debt bubble of epic proportions. But the most insidious thing about it may not be just its size, but rather how few people are even aware that it exists. The massive debt bubble, fueled both by the federal government and by corporations, has begun to receive a little bit of attention from the press, but the effects of that bubble are not appreciated by the vast majority of Americans.
Debt can be useful for many reasons, from buying a car or house to gaining the seed money necessary for starting a business. But when unqualified borrowers take on massive amounts of debt, the odds of that debt being repaid decline precipitously. And in a debt bubble like the one we have today, once those debts stop being repaid the bubble bursts violently.
We saw that happen during the 2008 financial crisis, when homeowners who stopped paying their mortgages caused the collapse of Wall Street behemoths such as Bear Stearns and Lehman Brothers. The entire economy shuddered as a series of debt defaults worked its way through the economy. By the time things were over, most investors had lost over half of their wealth as the economy teetered on the brink.
But the bubble that burst in 2008 was nowhere close to as big as the bubble that been built up today. Corporate debt is at record levels, with over $9 trillion of extant non-financial corporate debt, or nearly half of US GDP. When that debt stops being repaid, the bubble will burst.
Not only is the US corporate debt bubble larger than ever, but it is also riskier than ever. Nearly 60% of US corporate debt is BBB-rated, which is one step above junk status. If interest rates rise and the business outlook worsens, much of that debt could be downgraded to junk. That would trigger an automatic selloff on the part of pension funds and financial institutions that would lead to an avalanche in bond markets. Prices will tank and credit markets may freeze completely.
And why have corporations taken on that much debt? Why, to buy back their own stock. The stock bull market of the last three years isn’t because of a strengthened economy, but because of corporations issuing more and more debt to buy back their stock.
Buying back stock increases earnings per share, a key metric in determining CEO compensation, and increases the influence that key shareholders have over corporations. It does nothing to increase the profitability, efficiency, or long-term vitality of corporations. But those sky-high stock prices give the illusion that all is well with the economy.
Investors who look at their 401(k) account balances think that they’re rich, and they hope that the gains of the last few years will continue forever. But in reality they’re being hosed, being sold the illusion of gaining wealth while corporate fat cats enrich themselves through larger bonuses and exercising stock options.
Corporations aren’t the only ones drowning in debt either, as governments around the world continue their orgy of debt-fueled spending. Aided by their central banks, governments have unloaded trillions of dollars of debt into the world economy. But they can only do that as long as investors are buying. When investors start having to sell assets to cover losses as the economy crashes, that government debt bubble will burst too.
The debt bubble is set to burst, and when it does it will make 2008 look like a cake walk. Investors who haven’t taken the time to protect their assets before the bubble crashes risk losing far more money than they did in 2008. This could very well be Great Depression 2.0, with many investors losing 90% of their wealth.
But 2008 also gives investors a template for how to protect their wealth, by investing in gold as a hedge against financial crisis. Investors who invested in gold not only protected their wealth against the worst of the financial crisis’ effects on stock markets, but they also continued to outpace stock markets during the first several years of the recovery. With an economic collapse in the near future a virtual certainty, can you afford to remain unprepared?
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