The worldwide debt trap is closing on private investors, with inflation looming as an added threat.
Benjamin Franklin’s famous comment about there being nothing certain in the world other than death and taxes has stood the test of time, but perhaps needs updating for the next generation to include a third certainty: debt.
In Franklin’s time, debt was a problem caused largely by governments spending money they didn’t have on wars.
Not much has changed in the past 250 years because now we have governments spending money they don’t have fighting a war against a virus.
One of the tools used by government to spark economic activity during the pandemic is ultra-low (and even negative) interest rates to encourage investment.
Unfortunately, those same ultra-low rates have lured private investors into a debt trap, either by encouraging speculation on financial markets or in bidding up property prices.
It won’t end well because at some point borrowed money has to be paid back, and that’s when, as Warren Buffett says, we’ll get to see who’s been ‘swimming naked’.
Predictable and unpleasant events that will follow the debt blizzard building around the world, include:
• tax increases, as governments try to repair their debt-bloated balance sheets;
• insolvencies, as borrowers fail to refinance when debt deadlines arrive; and
• inflation, as governments take the easy way out of the problem they’ve created by encouraging price increases to ‘de-base’ their currencies.
Hints of what’s to come as the world continues its fight against COVID-19 can be seen in the tax debate developing in Europe and the US.
In Brussels, home of the European Union, disagreements are breaking out about how to fund a post-COVID recovery, with a plan to raise up to €15 billion ($25 billion) a year threatening another split among member states.
An expanded carbon tax and a levy on internet-based trading companies are on the EU agenda.
In Washington, fears of massive tax increases to fund a multitrillion-dollar recovery fund is causing concern for investors and management of major corporations being targeted for tax hikes.
Ann Miletti, a senior executive at Wells Fargo bank told the Financial Times newspaper that: “Everybody is kind of at a picnic right now, but you can see the potential for a [tax] storm coming in”.
Insolvencies have already started with the collapse of Greensill Bank and the failure of the Archegos investment fund, which has destabilised Credit Suisse.
At a personal level, the world’s debt binge will leave investors with a severe headache if they have been gambling with money borrowed at a nominal 1 per cent, only to discover that they have to pay it back at 3 per cent (and more).
In the US, a record $US814 billion has been loaned by banks to private investors to play the stock market, or on more obscure and higher-risk products such as Bitcoin.
The amount advanced to traders represents a 50 per cent increase on 12 months ago, a growth rate that is the fastest since 2007 (just before the GFC).
But the king hit that could be on the way is a return of inflation at levels not seen in 40 years, a time when prices rose at more than 20 per cent a year.
Alarmingly, governments are not the slightest bit worried about a return of inflation, although it’s unlikely they’re expecting a return to the levels of the 1970s and 1980s.
In fact, governments are encouraging a dose of inflation while hoping they can keep it down to a manageable level of 3 per cent to 5 per cent; wishful thinking, perhaps, once the inflation genie is out of the bottle.
Allowing inflation to run hot for a while seems to be a near certainty, perhaps up there with Franklin’s death and taxes warning, because it would reduce the burden on government finances by enabling them to repay their debts with inflated dollars, pounds and euros.
Pascal Blanque, chief investment officer at French fund manager Amundi, said recently that inflation was now seen as “desirable as a way out of the crisis by reducing the value of debts over time”.
Property investors and anyone with a taste for gold might do well in a high-inflation environment, but savers and pensioners will be in for a rough ride, as they were in the 1970s and 1980s.
