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Late-Stage Credit: When There Are No Buyers Left for Inflated Assets

Economic Prism  ( Original )
MAY 24, 2018

When Fed-printed dollars are flowing freely through the banking system and out to consumers, bidding wars break out for everything. Stocks, bonds, housing…free debt means lots of easy capital with which to overpay for assets. And whoever it willing to borrow the most can overpay the most.

What happens when that easy credit goes away? Suddenly, those previous buyers go to sell to the next bigger sucker taking out the next bigger loan…but that loan isn’t available anymore. Welcome to the bursting of the subprime real estate bubble. The bursting of the Everything Bubble awaits. As summer approaches, and dispositions loosen, something less amiable is happening.  Credit markets are tightening. The yield on the 10-Year Treasury note has exceeded 3.12 percent.

If yields continue to rise, this one thing will change everything.

When credit is cheap, and plentiful, individuals and businesses increase their borrowing to buy things they otherwise couldn’t afford. For example, individuals, with massive jumbo loans, bid up the price of houses. Businesses, flush with a seemingly endless supply of cheap credit, borrow money and use it to buy back shares of their stock…inflating its value and the value of executive stock options.

When credit is tight, the opposite happens.  Borrowing is reserved for activities that promise a high rate of return; one that exceeds the high rate of interest.  This has the effect of deflating the price of financial assets.

The Federal Reserve and the dollar don’t stand a chance. The rising part of the credit market cycle will be their death knell. But first, rising interest rates and deflating asset prices will wreak havoc and disaster on the world at large.

ORIGINAL SOURCE: Tales from “The Master of Disaster” by MN Gordon at Economic Prism on 5/18/18