The Debt Bubble | Seeking Alpha

Analysts are just really starting to realize the extent of the debt expansion that has taken place in recent years.

More and more discussion is taking place related to the $4.5 trillion the Federal Reserve injected into the economy during the 2020-2021 period and the resulting debt boom that exploded from there.

The Bond King, Bill Gross writes about “the Ponzi schemes–cryptocurrencies, non-fungible tokens, etc.–created aplenty by center banks under the cover of Covid” in the Financial Times.

But, this debt mountain has been growing for a substantial period of time.

I have been writing about the “credit inflation” of the past sixty years for over ten years now.

This credit inflation came about as the politicians in Washington, D.C., both Democrats and Republicans, created an environment where debt was generated almost constantly.

The idea came about in the 1960s as something called “the Phillips Curve,” a statistical relationship touted as showing that lower rates of unemployment could be attained at the cost of accepting a slightly higher rate of inflation…say, 2.0 percent inflation.

The thing is that if investors get accustomed to the rising inflation every year, they may find better investments that produce higher returns with less risk in other areas of the economy, like rising asset prices like gold, housing prices, commodities, stock prices, and so on.

The initial efforts to produce this credit inflation actually created an inflation problem that was overcome by the efforts of Paul Volcker and the Fed.

But, moving further into the 1980s, investors saw that putting more and more of the government’s stimulus money into assets rather than in consumer goods produced very acceptable returns, and so we saw more and more of the stimulus monies going into the financial circuit of the economy, with less and less going into the real sector.

And, as credit inflation evolved, more and more sophisticated means were found to place these stimulus monies into asset price inflation rather than in consumer price inflation.

Analysts are still undercovering how money was being transferred throughout the economy to take advantage of “credit inflation” to pump up returns at lesser risk.

Ruchir Sharma writes in the Financial Times:

“Since 2000, the assets managed by private markets have risen elevenfold–over four times faster than the stock markets.”

“The markets gap has widened particularly fast since 2018 when a period of market volatility ended with the Fed abandoning a turn to tighter monetary policy.”

Mr. Sharma notes that

“nearly 100 percent of the loans private funds use to finance buyouts are ‘covenant lite’–condition free–up from zero percent a decade ago.”

Furthermore,

“Private equity funds (in the United States) raised more than $1.0 trillion last year, up a record 20 percent.”

Bill Gross adds in more numbers. He writes that the Bank of International Settlements claims that “hidden ‘shadow bank’ debt may be as high as $65.0 trillion, more than 2 1/2 times the size of the entire Treasury markets and that most of it is owed to banks.”

Wow!

As the Federal Reserve, and other central banks around the world, move to further tighten up on monetary policy, analysts are bringing to light more and more places that “extra loose” monetary policies flowed into over the past several decades, extra loose policies that looked small when compared to the amount of central bank money that was poured into the financial markets over the past few years.

What we are coming to understand, as Bill Gross comments on in his closing paragraph, is the world has “Too much hidden leverage, too much shadow debt behind closed doors.”

How much is really out there? We don’t fully know.

What is becoming more and more apparent is that a successful Federal Reserve policy in combating inflationary pressures may require much, much more work than was originally foreseen.

The Federal Reserve put a massive amount of funds into the banking system.

The banking system expanded these “fundamental reserves” into more and more debt, both public…and private.

The “private” bubble is turning out to be way far in excess of what many analysts believed it to be in the past.

And, this is always the problem of a central bank that gets “out of control.”

Things usually look pretty good as the central bank is working to expand financial assets and get the economy growing and continuing to grow.

Then the next day comes, the day when the central bank has to start making up for the excesses it created at an earlier time.

A “tight money era” begins.

We are now in that era of “tight money.”

Mr. Sharma concludes his piece in the Financial Times by writing,

“In the end, there will be nowhere to hide in a tight money era.”

“And private markets, which largely built returns on heavy and loose borrowing, are more vulnerable than public markets in this new age.”

And, so we move on.

So too, does the Federal Reserve.

The big problem is that bubbles are hard to control, especially when one is trying to make the bubble smaller.

This is certainly going to be an era of radical uncertainty.