One of the greatest costs of the credit bubble that has enveloped the world the past 15 years is that it has allowed the price of most assets and services to skyrocket. In a sustainable equilibrium, available capital to fund investment comes from savings. But when as now, the banking system is flooded with credit on credit from a recklessly levered financial sector, for a time it makes capital plentiful and therefore less valuable. Since less valuable, capital is rewarded with lower and lower yields.
Using borrowed money, more people have the ability to buy, and hence the price of most services and assets rises with the demand. Until finally we reach the end point of borrowing capacity, the end of debt service ability (ie., no matter how low rates are, repayment ability is ultimately finite because it is tethered to one’s available cash flow collected through sales or wages). At the end point, credit slows and the inevitable payback period exacts its pound of flesh: years of reduced consumption courtesy of servicing costs, defaults, write-downs, bankruptcies and of course, mean reverting prices for assets and services. All of a sudden, reality reveals that few people actually have liquid savings, and hence few can afford to be buyers. And if at all, only at much lower prices.
A present example of these forces at work, is in post-secondary education. Education costs have skyrocketed because students have been able to access seemingly endless credit and so schools have been able to dramatically jack up costs and still find customers. But the end point of this ‘virtuous cycle’ seems to upon us. Students are increasingly already in debt by the time they reach college (car loans and credit cards) and then even after graduating, many are not able to earn enough to payback their loans and start a household–for years–as the debt weight of past consumption stifles new.
Student loans continue to pile up, now totaling $1.16 trillion in outstanding balances, one of the main reasons researchers have cited for the low levels home ownership among young adults. Here is a direct video link.
But it’s not just students or Greeks who are now suffering the paralyzing effects of impossible debt levels. It’s worldwide:
Despite widespread talk of “deleveraging” after a global credit bubble burst in 2008, the world continues to pile on more debt. According to a new study by McKinsey, the world ended last year some $57 trillion deeper in debt than it was in 2007.
The total tab—owed by governments, companies and households—is now more than twice the value of the world’s total economic output.
The biggest chunk of new borrowing since 2007—some $25 trillion—has come from governments going deeper into hock. Of the nearly 50 countries included in the analysis, only five—Argentina, Egypt, Israel, Romania and Saudi Arabia—have paid down some of their debt.
As shown on this historically reliable metric (and many others!) stock prices today are the most over-valued in 115 years, but for the fleeting tech wreck top in 2000:
