Jul 25, 2011

Forget the Debt Ceiling, This is the Real Debt Problem

By Andrew Mickey, Q1 Publishing

By Andrew Mickey, Q1 Publishing

The last few weeks have brought weakening economic numbers, stellar earnings reports, political theatrics, record gold prices, and the first hint at a potential QE3.

All the “good” news has pushed the Dow back to just 10% below its all-time highs from October 2007.

In times like these, when fear of missing out outweighs fear of a market downturn, we have to reiterate this all will end badly.

But, it’s not likely to end badly soon. Here’s why it will last far longer than most expect and the warning signs to look for when the bubble-in-everything will start to deflate.

----------------------Special Offer-----------------------
The Best Deal Available on Our Most Popular Service

For Prosperity Dispatch readers we’re opening up the doors to our most popular advisory service for less than 50 cents a day!

Take advantage of this exclusive offer now.
----------------------------------------------------------------

Borrowing Your Way out of Debt Crisis

It’s no secret the driving force behind the current rally has been a continued increase in money supply. It’s something we talked about since the first month this rally began.

The massive amounts of fiscal stimulus created in response to the 2008 credit crisis had to go somewhere. And since March 2009 the money has chased all asset classes from bonds to gold.

It’s not likely to stop anytime soon either. The Fed has printed trillions of dollars and maintained policies to ensure maximum profits and expanded capital bases for banks and other institutions to drive markets. In Europe too, the European Union continues to paper over debt problems and will continue to do so.

The temporary solution to the ongoing economic malaise and debt crises past and future will be more spending, borrowing, and printing.

Behind it all though has been a very serious problem. One that shows 2008 was just a preview of what will happen when the current bubble bursts. Here’s why.

“Risk Free” Gets Much Riskier

The ridiculous amount of debt which has been run up in response to global real estate/banking/credit crisis is just a part of the problem.

A much bigger part of the problem will be paying those balances down or (the more likely scenario) keeping an ever-larger bubble expanding.

The problem right now is that very few investors are concerned about the real quality of the debt and the borrowers’ ability to repay them.

The chart below from the Financial Times shows how the vast majority of debt has been rated virtually “risk free” by the major rating agencies:

As you can see, ratings agencies have consistently rated more and more debt the as virtually “risk free.”

From 1990 to 2008 the percentage of AAA-rated debt exploded from well under 10% of debt to a high of nearly 50% in 2006.

When that debt turned out to be a little bit riskier than though…well, we ended up with the 2008 credit crunch.

Jump ahead to today and the rating agencies have become even more generous. In 2009, the last full year analyzed, the percentage of debt rated AAA has exploded to more than 60%.

Standard & Poor’s defines AAA rating as the borrower having an “extremely strong capacity to meet financial commitments.”

There’s no way 60% of borrowers have a strong capacity to meet their financial commitments.

It has come to point where the more debt that gets issued, the greater share of it receives top billing from the ratings agencies.

It’s the equivalent of you getting a higher credit rating the more you borrow.  It’s complete nonsense. And we’ve already seen how it all ends. This too will end badly. But the big question is when.

The Coming $8 Trillion Test

The 2008 credit crunch was merely a preview of what will eventually come. The key word is eventually.

The explosion of top-rated debt over the past few years cannot and will not last. But as long as it keeps moving forward, it’s not a trend to bet against.

Once you start to see the signs we saw in early 2007 and 2008, you’ll know the end won’t be too far off.

For instance, look for the ratings agencies to start downgrading the debt from AAA to AA even though a real analysis would show the debt really deserves official junk status.

Also, look for central banks to preemptively cut interest rates or printing more money if their rates are already set at zero.

And the most apparent indicator will be when governments and central banks confidently stating how it’s all “contained,” limited, or some variation of move-along-nothing-to-see-here.

Finally, the debt markets will be facing a major test in the next few months and years. Standard & Poor’s estimates that $8 trillion in corporate debt needs to be refinanced (or “rolled over”) between 2012 and 2015. As long as the credit is available, this will pass with little notice. If credit starts to seize up, however, the wheels will fall off it very quickly and it will be time to run for the exits.

For now though, the debt-fueled party is still going. And it’s still best to buy the assets that will perform best in a growing debt bubble like precious metals, energy, and other real assets while keeping your eye towards the exits. Because when the line-up at the exit gets big, it will be too late.

Good investing,

Andrew Mickey
Chief Investment Strategist, Q1 Publishing

-----------------------Special Offer-----------------------
The Best $29 Investment You’ll Ever Make

We recently put together our best offer yet. Our investment research will pay for itself within three months or we’ll give you a 100% refund – no questions asked.

Take advantage of this special offer today.
-----------------------------------------------------------------