Reckless Mistakes
False price signals distorted by decades of extreme government intervention have compelled Americans into reckless spending, saving and investment habits. The wide range of mistakes that have taken place are irreversible.
Low-interest rates, courtesy of Federal Reserve balance sheet expansion, made people think they could borrow more money than they really could.
The yield on the 10-Year Treasury Note is currently at about 4.11%. Apart from a brief moment last fall, the 10-Year Treasury yield hasn’t topped 4% since mid-2008. In other words, borrowing costs haven’t been this high in over 15 years.
The direct consequences are obvious. And should have been expected.
As the price of credit increases, debt servicing costs increase too. This is no mystery. Borrowers — including individuals, businesses and governments – must now direct a greater share of their capital into paying their debts than they did a year ago.
For some, this is no big deal. They didn’t take the bait of the Fed’s artificially cheap credit. Their debts remained moderate. They continued to live within their means, with some income left over for savings and investments. They have ample cashflow to cover the increased debt burdens from higher interest rates.
For others, it’s a major problem. They’re up to their eyeballs in debt. They borrowed and spent money as if there was nothing to lose. During the second quarter of 2023, for example, total credit card debt in America topped $1 trillion for the first time ever.
In truth, consumers have been using credit cards to maintain their standard of living in an era of rising consumer prices. Yet this cannot go on forever. The bills always come due at the worst possible time.
Voices in the Night
This massive glut of credit card debt has arrived at a most inopportune moment. As the Fed hiked interest rates over the last 18 months, credit card rates have gone up too. The average credit card rate is now more than 20% — an all-time high.
To be clear, 20% isn’t quite a loan shark rate. And debtors won’t get their kneecaps busted for not paying. But it’s pretty doggone awful.
People, in short, have locked themselves into a life of misery. And they’re not going to be happy about it when the full force of their reality sets in.
What will happen to the financial system when the broad populace refuses to dedicate a large percentage of its waking hours to paying off bankers?
On top of that, student loan interest will resume starting on September 1, 2023, and borrowers will have to restart payments in October. If you recall, student loan payments and interest have been paused since March 13, 2020.
So, after nearly three and a half years of interim mercy, the relentless reality of student debt is returning like voices in the night.
For those burdened with student loans and maxed out credit cards, every dollar counts. When interest rates rise, they especially feel the pinch. They must cut back on other expenses to free up cash.
Some may cancel their streaming services and dust off their library cards. They may stop eating out at restaurants. They may downsize or move into their parent’s basement. They may take on a second job — or take to pushing a hotdog cart.
Others, however, will find it impossible to meet their financial obligations. Their debts are too overwhelming. They will be forced to declare bankruptcy.
In addition, this same dynamic of over indebtedness within an environment of relatively higher interest rates is also playing out in other areas of the economy — not just for consumers.
Higher Debt Costs
Businesses, like individuals, will also struggle to generate the cash flow needed to cover obligations. Operations that could be easily financed two years ago may no longer pencil out at today’s rates.
Thus, management is forced to make tough decisions. They must tighten their belts. Scale back development. Shutter divisions. Reduce the workforce.
Alas, over the next few years, the pinch from higher interest rates that businesses are feeling will turn into a bone crushing vice. Here’s why.
According to a recent client note from Goldman Sachs, an estimated $1.8 trillion of U.S. corporate debt is coming due in the next two years. This is a big problem because the debt will need to be refinanced at much higher rates.
Corporations needing to refinance existing maturing debt at today’s higher rates would face higher debt costs. Goldman’s economics team, led by Jan Hatzius, expect a 2% increase in interest expenses for corporations in 2024 and a 5.5% jump in 2025.
Naturally, as corporate debt payments increase, cuts to labor and capital expenditures follow. In fact, using data from public companies since 1965, Goldman found that for each additional dollar of interest expense, companies cut capital expenditures by 10 cents and labor costs by 20 cents.
By this, the strong labor market and low unemployment rate that President Biden and Treasury Secretary Yellen point to as justification for a robust and healthy economy, will turn soft over the next two years as maturing debt is refinanced.
Businesses, facing this certainty, will be forced to lay off workers at a time of record consumer debt. And as the unemployment rate increases, consumer debt will go unpaid.
Tasting the Forbidden Fruit
Some businesses won’t just be forced to layoff workers. Rather, their debt burden will result in bankruptcy filings.
Already in 2023, Chapter 11 filings have exceeded total filings for the entirety of 2022. What’s more, U.S. corporate bankruptcies are at their highest level since 2010. Several notable corporate bankruptcy filings this year include Bed Bath & Beyond, Virgin Orbit, Yellow Corp., SVB Financial Group, Diebold Nixdorf, Serta Simmons Bedding and Party City.
Some of these companies will be able to reorganize, restructure their debt, and dig their way out of the grave they put themselves in. They’ll stiff their creditors and go lean and mean. Others, after concerted effort, will disappear from the face of the earth forever.
The years ahead, no doubt, are going to be rough for businesses and workers. And today’s calls of a soft landing will prove to be nothing more than wishful thinking.
Make no mistake, consumers and businesses got themselves into this mess. No one held a gun to their heads and forced them to borrow money. They did it to themselves.
What did they think would happen when they were piling on record debt while interest rates were at 5,000-year lows? Obviously, not much thinking was going on at all.
But let’s not forget, it was the Fed, in concert with the Treasury, who offered up the forbidden fruit of artificially cheap credit. This magical and intoxicating promise was something too irresistibly tasty for many to pass up.
They took a bite. Then they took another. They “shall surely die.”
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