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We were wrongly conditioned to believe asset prices rose because of inflation. One would have thought we learned our lesson in the early 80s when Oil (and Gold) crashed in price while inflation continued.

More Debt More Better

May 1st, 2014 by Kurt L. Smith
  • I was wrong. The great Credit Expansion Finished didn’t end with the financial crisis; the great Credit Expansion merely took a reprieve. While the effects of the reprieve were mighty indeed, with stock and bond prices plunging, I was wrong to believe Credit Expansion Finished. Total credit (debt) has now soared to new highs largely taking stock and bond prices right back up with it.

    I was wrong and I am sorry. The narrative spoke to what I believed to be a highly correlated and extremely important relationship: shrinking debt means shrinking asset prices. I wasn’t wrong with that statement; I was wrong to believe that shrinking debt in the early years of the financial crisis was the beginning of a new trend. It was not.

    Credit Expansion has continued to new stratospheric heights. The days of financial engineering are not over, they merely were in the process of shifting into overdrive. Sure governments here and around the world have issued trillions of dollars in new debt but so have large corporations. Stock buybacks, leveraged buyouts, covenant-lite junk bonds and other financial engineering efforts have helped send total debt to new record amounts.

    Does the higher debt, higher asset prices still hold? Absolutely! Should I have counseled you to buy cheap stocks, junk bonds and other leveraged assets that have since appreciated in value? Perhaps. You would now however have a portfolio of high priced, formerly cheap assets including junk and leveraged items. In other words, you would own a portfolio that you would have to sell at some point in order to realize your returns. So no, I won’t be apologizing for the current makeup of your portfolio as it is probably as close to the opposite of leveraged and junky as it can be.
    Obviously more debt must be more better. Of course this has been the case for your entire life, save a few years in the early nineties and the first few years of the financial crisis. We have learned (over and over again) the answer to our financial problems is more debt and eventually we will get it and asset prices invariably recover. How many times has this proven to be the case over just the past twenty five years?

    Increasing debt forever (or at least until we or are loved one’s are no longer here) should be our mantra. Everyone loves higher prices…it is just so…consistent. There should never again be a period in which debt shrinks (thank you Federal Reserve!) because who needs that aggravation and besides wasn’t this the reason the Federal Reserve was created?
    We have the Fed to thank for creating the situation in which everyone preaches the value of buying ever-increasing-in-price assets backed by ever-increasing debt. So what if people are being left behind (the Millenials, the poor, your neighbors)? If those people were just smart enough to follow the Fed and borrow money to buy ever-increasing-in-price assets then they would not be poor. Everyone should follow the Fed!

    Our future is too important to be put at risk, so therefore we need to ensure the level of debt is always increasing! I am sure you agree; who wouldn’t? So thank goodness the Fed and the largest of the corporations recognized the problem I spelled out (Credit Expansion Finished) and were determined not to let me be right. Thank goodness they came to our rescue.

    You only thought inflation was the reason asset prices moved up in price. They might call it inflation but the real culprit was ever expanding debt. We were wrongly conditioned to believe asset prices rose because of inflation. One would have thought we learned our lesson in the early 80s when Oil (and Gold) crashed in price while inflation continued. One would have thought we were disabused of this notion as well when housing prices crashed before the financial crisis in 2007, again while inflation continued its (albeit slow) march. But no, people still connect inflation and higher prices.

    We know better. It wasn’t inflation after all but rising debt levels that we should applaud for rising asset prices. However, it is okay to use the word inflation when speaking of the great Credit Expansion because it will help you use the term deflation to describe credit contraction. This is why you are now beginning to see the word deflation described as a four letter word: deflation means credit contraction and now we know what that means (falling asset prices).

    There is Icarus, letting Daedalus know not to get too close to the sun. Yet credit expansion is back and growing to the sun and eventually Icarus’ warnings will prove true. After every credit (debt) binge it has always been thus. I am glad the powers that be read my monthly letter so they know what to do to prove me wrong. More debt more better!

    North East Independent School District, TX Moody: Aaa (Aa1 Underlying) S&P: AAA (AA- Underlying)
    Permanent School Fund Guaranteed
    DUE 8/1 DATED 4/15/14 MATURITY: 8/1/2033
    SALE AMOUNT: $121,735,000

    YEAR MATURITY COUPON YTM*
    1 2015 2.00% 0.21%
    2 2016 5.00% 0.41%
    3 2017 5.00% 0.71%
    4 2018 5.00% 1.05%
    5 2019 5.00% 1.34%
    6 2020 5.00% 1.64%
    7 2021 5.00% 1.93%
    8 2022 5.00% 2.14%
    9 2023 5.00% 2.32%
    10 2024** 5.00% 2.45%
    11 2025** 5.00% 2.57%
    12 2026** 5.00% 2.68%
    13 2027** 4.00% 2.94%
    13 2027** 5.00% 2.77%
    14 2028** 5.00% 2.87%
    15 2029** 5.00% 2.95%
    16 2030** 4.00% 3.25%
    17 2031** 4.00% 3.33%
    18 2032** 4.00% 3.41%
    19 2033** 4.00% 3.49%

    *Yield to Worst (Call or Maturity) **Par Call: 8/1/2023
    Source: Bloomberg
    This is an example of a new issue priced the week of 4/28/14
    Prices, yields and availability subject to change

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