“The bank is something more than men, I tell you. It’s the monster. Men made it, but they can’t control it.” – John Steinbeck, The Grapes of Wrath
Mass Infusions of New Credit
Recently, an unusual event unfolded in the financial markets. On a Tuesday, the price of gold surged by over $13 per ounce. While this isn’t groundbreaking news, it coincidentally occurred as the yield on the 10-Year Treasury note slid down to 2.15 percent.
This situation led investors to anticipate both inflation and deflation simultaneously—a paradox of sorts. Such conflicting signals hint at underlying anomalies in the market dynamics.
By late Wednesday and into Thursday, the opposite occurred: gold retraced nearly all of its Tuesday gains, and the yield on the 10-Year Treasury note climbed back to 2.19 percent. What could be causing these erratic shifts?
One might speculate on the source of funds for Treasury bond purchases. Central bank interventions likely play a significant role, although the Federal Reserve is not the sole player.
Recall that the Federal Reserve’s quantitative easing ended in late 2014, with plans to reduce its balance sheet in the near future. If the Fed isn’t the source of liquidity for Treasury purchases, then who is?
Notably, the People’s Bank of China and the Bank of Japan are significant buyers of U.S. Treasuries. After liquidating some of its holdings in 2016, the People’s Bank of China is now back in the market, actively buying again. Additionally, regional Japanese banks have ramped up their Treasury holdings by over 80 percent in just five years.
Currently, Europe is also contributing to the influx of new credit, as Treasury purchases are driven by the European Central Bank’s ongoing quantitative easing program. Earlier this week, ECB President Mario Draghi announced the retention of interest rates at 0.0 percent, with a willingness to extend quantitative easing if necessary. In his view, Europe is struggling to generate the inflation needed to halt the monetary spigot.
Unsustainable Loan Burdens
While the U.S. government appears able to borrow and spend without constraints, American consumers are reaching a breaking point. Unfortunately, this trend often coincides with dire circumstances.
Since early 2009, consumer debt in the U.S. has skyrocketed, encompassing student loans, auto loans, and credit card debt, accumulating to staggering amounts. The reality is that American consumers have borrowed nearly $13 trillion—far exceeding what they can realistically repay—amidst stagnant wages.
Matt Scully from Bloomberg elaborates on this troubling situation:
“Americans, facing minimal income growth, have turned increasingly to debt to finance their spending. Early indications suggest that loan burdens are becoming unsustainably high for lower-income borrowers. Total household debt has surged to a record $12.73 trillion, with overdue debt rising for two consecutive quarters.”
“Concerns are growing among companies regarding their customers’ financial health. In April, Public Storage noted an increase in stressed self-storage clients, and credit card lenders like Synchrony Financial and Capital One are preparing for increased defaults.”
Clearly, they will need substantial reserves to manage bad debts—this trend seems set to continue.
The Three-Headed Debt Monster That’s Going to Rampage the Economy
It’s essential to recognize that bad debt will not simply disappear. Over time, it spreads through the financial system like a formidable three-headed monster. Initially, its presence may go unnoticed, but it can quickly wreak havoc, leaving chaos in its path.
This three-headed debt monster is composed of student loans, auto loans, and credit card debt—all problematic due to their lack of collateral.
Where is the collateral?
In the case of student loans, the funds have likely been allocated to inflated professor salaries, large lecture halls, and extravagant sports facilities—none of which can be recovered. Similarly, credit card debt is often incurred for non-essential items like large televisions and dining out—how can a lender reclaim the cost of a meal consumed two years ago?
Auto loans have some collateral, as cars can indeed be repossessed. However, new cars depreciate almost instantaneously, often resulting in loans that exceed the value of the vehicle—a troubling trend. Record levels of auto loans today are backed by cars that carry negative equity—the debt exceeds the worth of the car.
Moreover, lenient lending standards from the past eight years have led many buyers to roll negative equity into new loans. Adding to this instability, some lenders only verified income for a mere 8 percent of their auto loans, prioritizing the sale of package deals to unsuspecting investors over prudent lending practices.
This three-headed debt monster has been meticulously constructed over the past eight years through easy credit, eager lenders, and consumers struggling to keep afloat. Policymakers, particularly former Fed chairs Bernanke and Yellen, have laid out the blueprint for this troubling environment. The notion that the resilient American consumer would absorb the affordable credit and drive the economy back to robust growth has proven to be flawed.
Who do you think should face the three-headed monster for breakfast?
Sincerely,
MN Gordon
for Economic Prism
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