The key insight of the Austrian School of Economics (maybe the key insight of ALL economics) is that the amount you borrow matters, but so does the use to which you put the money.
A case in point is US corporate debt, which has changed structurally lately in very scary ways. The short version of the story is that after the US cut interest rates to historically low levels to keep the Great Recession from swapping it’s capital R for a capital D, public companies figured out that they could borrow money for less than their stocks’ dividend yield, use the proceeds to buy back their outstanding shares, and generate free cash flow in the process. And – a nice added perk – the increased demand pushed their share price up and landed their CEOs even bigger year-end bonuses.
So that’s what they did, on an epic scale.
But – recall the Austrian School insight – the result was soaring debt without any new productive assets to offset the cost.
Generally speaking, debt rising faster than operating income equals diminished creditworthiness. So all that borrowing has produced several trillion dollars of debt that’s just one step above junk. Here’s an excerpt from money manager Louis Gave’s take on the subject:
The Size of Corporate Debt One Rung Above Junk Has Never Been Greater, Warns Louis Gave
Louis Gave at Gavekal Research says the greatest source of potential instability in the years ahead lies with the massive growth of the U.S. corporate debt market, particularly at the BBB-rated (near junk) level.
Gave recently told FS Insider that it has far outpaced the economy and could be due for a reset during the next downturn, which is increasingly becoming a concern by other strategists.
When it comes to potential trouble spots brewing in the financial markets or global economy, Gave said “if you ask a French client, they tend to point a finger at Italy. If you ask Italian clients, they point a finger at Deutsche Bank; and if you ask German clients, they point a finger at France. When I talk to my U.S. clients, most of them point a finger at China, which they see as having unsustainable high levels of debt and is an accident waiting to happen.”
However, Gave sees an even source of potential problems since, as he points out, the “size of corporate debt one rung above junk has never been greater.”
Read the full article at ZeroHedge: What Blows Up First? | ZeroHedge