Post #2
The Great Reset
Key takeaways:
• A crisis in high-yield corporate debt will be the beginning of “The Great Reset.”
• As lower-quality corporate bonds drop to junk status, institutional investors will be forced to sell, drying up liquidity.
• The selling will spill over into stocks and eventually trigger a recession.
• As the recession unfolds, the Fed and other central banks will pull back from QE reversal plans.
• The world has too much debt, which will force governments to find a way to “reset” it.
• All of this will lead to the most volatile decade in US history.
In the previous chapter, I described the coming credit crisis as a potential trigger for the next recession. The core problem will be what I mentioned: illiquidity. Trading can and will dry up in a heartbeat at the very time people want to sell. In late 2008, the high-yield bond benchmarks lost a third of their value within a few weeks, and many individual bond issues lost much more, in large part because buyers disappeared. The same thing happened in the dot-com recession, though not quite as dramatically.
There were several whipsaws and a particularly terrible month in June 2002.
This time, I believe the collapse will go deeper and happen faster because Dodd-Frank has reduced market makers’ ability to cushion it. Likewise, the Fed will be reluctant to bail out ridiculously priced bonds like WeWork and its many covenant-lite, unsecured brethren. But the initial credit crisis stemming from the fall of high-yield bonds will be merely the beginning of woes.
Illiquidity will spread as lower-quality corporate bonds drop to junk ratings. Legal and contractual constraints will force institutions to sell, pressuring all except the highest grade corporate and sovereign bonds. Treasury and prime-rated corporate bond yields will go down, not up (see 2008 for reference on this). The selling will spill over into stocks and trigger a real bear market—much worse than the hiccups we saw earlier this year. I give the probability of a credit crisis in the high-yield junk bond market somewhere close to 95%. Nothing is 100% certain, but I think this is pretty much baked in the cake.
Lending Drought
Remember how I described the new cycle in the previous chapter. Instead of recession pushing asset prices lower, lower asset prices trigger the recession. That will be the next stage as falling stock and bond prices hit borrowers. Rising defaults will force banks to reduce their lending exposure, drying up capital for otherwise creditworthy businesses. That will put pressure on earnings and reduce economic activity, and a recession will follow. This will not be just a US headache, either. It will surely spill over into Europe (and may even start there) and then into the rest of the world. The US and/or European recession will become a global recession, as happened in 2008.
As always, a US recession will spark higher federal spending and reduce tax revenue, so I expect the budget deficit to quickly reach $2 trillion or more. Within four years of the recession’s onset, total government debt will be at least $30 trillion. All of this will further constrain the private capital markets and likely raise tax burdens for everyone—not just the rich. The Great Reset As this recession unfolds, we will see the Fed and other developed-world central banks abandon their plans to reverse QE programs. I think the Federal Reserve’s balance sheet assets could approach $20 trillion later in the next decade—roughly quintuple what they did after 2008. They won’t need to worry about the deflation that usually accompanies such deep recessions (dare we say depression?), because the Treasury will be injecting lots of high-powered money into the economy via deficit spending. That’s what they will do, but it won’t work.
The world simply has too much debt, much of it (perhaps most) unpayable. At some point, the major central banks of the world and their governments will do the unthinkable and agree to “reset” the debt. It doesn’t matter how, they just will. They’ll make the debt disappear via something like an Old Testament Jubilee. I know that’s stunning, but it’s really the only possible solution to the global debt problem. Pundits and economists will insist “it can’t be done” right up to the moment it happens—probably planned in secret and announced suddenly. Jaws will drop, and net lenders will lose.
While all that is brewing, technology will keep killing jobs. It’s projected that 20–40 million jobs will be lost in the US alone and hundreds of millions across the developed world. As we get into the 2020s, the presidency and Congress will again be whipsawed, and we will begin to discuss Bernie Sanders’ “crazy” universal basic employment idea, or others like it. By then, the idea will not be considered crazy, but the only feasible choice. All of this is going to lead to the most tumultuous decade in US history, even if we (hopefully) avoid throwing a war into the mix.
If we somehow get through all that, and particularly the Great Reset, the 2030s should be pretty good. In fact, think incredible boom. No one in 2039 will want to go back to the good old days of the 2020s. Our kids will think it was the Stone Age. But we have to get there first. The good news is that there is still plenty of time to prepare, but you need to start planning now.
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