There is No New Way to Go Broke

That however is just the beginning. We suspect that this is the oncoming of a long, slow and painful loosen up of the excesses of the last five years.

Along with decompression comes a tick up in defaults, and we anticipate those to increase in 2016 and 2017.

Bank of America Merrill Lynch Credit Analysis, September 2015

(Along with my emphasis)

There is no brand new way to go broke. It is always too much debt.

This has been the case since the development of money and credit. Be lent more than you can service, and you and your creditors have a problem.

This is exactly what happened in 2007 along with subprime borrowers. When the honeymoon curiosity period was over, they quickly learned their incomes could not service the debt costs. Default.

On a daily basis the financial press is full of trees and shrubs. The dietary plan of detail is fine if you want to trade the market. And quite frankly, by the time its in the paper, the inside money has already been there and done that.

For the rest of us, who’re looking to protect or market our capital, we have to remain back and see the woodland.

The world is sitting on top of an official debt pile associated with US$200 trillion and counting. Because the GFC, global debt has increased by around US$60 trillion.

Low interest rates facilitated this six-year long debt binge.

Corporates chasing cash (to fund reveal buy-backs, triggering hefty executive bonuses) and investors chasing cash, were a perfect match. Company borrowers offering a % or two above the cash rate or a swap rate were swamped with dollars from investors eager to get some return on their capital.

Its long been my personal contention the next and far stronger GFC will come from a credit fall behind on such a scale that all the Feds horses and men will not put the system together again.

The US$60 trillion in post GFC debt that poured into the worldwide economy was a masking broker. It looks like genuine economic activity however it was nothing more than a stimulant with no lasting productive worth.

Now that investors are drawn on out or not stupid enough to give cash to junk bond rated corporates offering pennies the game of finding a larger fool to give you money is ending.

The credit squeeze is influencing business revenues lower prices mean more sales are needed to create the revenue required to meet costs. The more prices fall, the greater sales needed. The problem is: there is only so much demand. Creating more doesnt necessarily translate into product sales. But over-production does lead to a deflationary spiral.

Heavily indebted corporates think Glencore are rushing to shore up their own balance sheets with assets sales and capital increasing.

What happens when more corporates start to have the revenue pinch? More asset sales and more capital increasing? Good luck with that.

Distressed sellers hardly ever if ever manage to extract a reasonable price for assets. Much less indebted competitors will be snapping up bargains.

When your solvency is questionable only lotto winning idiots would participate in the capital raising.

When you cant lower your debt to a level your revenue can service, you default or you ask for a financial debt restructure.

According to Bank of the usa the level of defaults in 2016C17 are expected to increase.

The Bank of America Merrill Lynch statement describes the current situation in the US as a slow moving train wreck that seems to be speeding up.

At present investors in company debt are probably going to hang in therethey need the return on their money.

But there will be a tipping stage when investors switch their own investment priority from return on their money to return of their money. So when they do it will be a stampede.

A fortunate few might get out. But most will be trampled in the rush to the exits. Most investors, through greed or the fear of missing out, leave the Im outa here decision until a minute too late. The tipping point can come very quickly.

Imagine a packed auditorium of a handful of thousand people, and one individual leaves. No one takes much notice. If that one person is actually followed by five others, individuals might start to wonder whats going on. If those five are suddenly followed by another Ten people in a hurried method, the crowd becomes a little worried. Itll only take another 20 people to scurry out and pretty soon the crowd is on its ft rushing the exits. It takes only around 2% to panic the rest of the 98%.

When the panic sets in, industry will be crowded with troubled corporates desperately selling assets to remain afloat. Cashed up traders are going to be able to buy property at deeply discounted amounts.

Yes that right, cashed up investors you know those silly investors who were told by the investment industry that cash is trash; cash is dead money; cash is not really an asset. The ones who refused to be pushed into playing the central lenders chase the higher yield game.

While cashed up investors are having the time of their lives selecting and choosing from the bargain box, bond holders will be in a world of hurt. They wont get their much needed interest payments and can only sit and wonder how much, if any, of their capital will be returned to them in the years to comeafter the lawyers have feasted on the corporate carcass.

This folks, may be the bigger picture. Bank of America put it succinctly with this commentary (emphasis is actually mine):

The weakness in high yield credit is to all of us not just a commodity story; it is about highly indebted borrowers can not grow, an investor base that can’t digest more risk, a market that has usually struggled along with liquidity and an economy that refuses to rise above mediocrity.

I can assure you there will be nothing mediocre about the next GFC.

The implosion of a few hundred billion dollars of subprime debt delivered us the GFC in 2008a time period that at the time drew comparisons with The Great Depression.

Pray let me know what is it going to be like when trillions of dollars within corporate and sovereign debt is destroyed?

There is no new way to go shattered. And with US$200 trillion in debt available Ill bet were going to see some very spectacular blow-ups in the next couple of years.

The destruction of wealth which awaits us is going to make the losses of the past couple of months seem like pocket change.

The Greater Depression is comingeven Wall Street is beginning to sound the caution bells.

Regards,

Vern Gowdie,

Editor, The Gowdie Letter

Editors Note: The above article was originally published within The Daily Reckoning.