Bolsonomics: the reform plans of Brazil’s new president  

Does Jair Bolsonaro have the political will to push through his economic proposals?

Joe Leahy and Andres Schipani in São Paulo



When department store chain Havan opened in Brasília in November, customers were greeted with a curious sight. Lying prone in the car park was a 35-metre-long replica of the Statue of Liberty.

Havan’s owner, Brazilian businessman Luciano Hang, has turned the statue into a group trademark — similar lady liberties hold their torches aloft over his stores in malls across Latin America’s largest country.

But in Brasília, the conservative entrepreneur who is a staunch supporter of Brazil’s president-elect, the far-right politician Jair Bolsonaro, was barred from erecting the statue because of bylaws limiting the height of advertising.

The sort of red tape that grounded the replica was for Bolsonaro stalwarts a microcosm of the malaise afflicting Brazil. With his appointment of Brazilian investor Paulo Guedes, a PhD in economics from the University of Chicago, as economy minister, Mr Bolsonaro has pledged to end Brazil’s historic legacy of overbearing bureaucracy and usher in a more American style of capitalism when he assumes office on January 1.

“The Brazilian state is broken. So there is a historic opportunity to really move Brazil torwards a free market,” says Carlos Langoni, a former central bank president. Or as a supporter of Havan’s Mr Hang put it on Twitter, referring to the upcoming inauguration: “President Bolsonaro will ascend the ramp and the statue will rise as well.”

Yet for all the sound and fury of October’s bitterly fought presidential election, Mr Bolsonaro said little of substance during the campaign about what he intended to do about the economy.

Known for his disparaging remarks about women and gay and black people as well as his defence of torturers from Brazil’s former military dictatorship, the gruff former army captain used social media to exploit popular anger with a deep recession and corruption. Many voters saw him as the antidote to the leftist Workers’ party, or PT, whose founder and former president Luiz Inácio Lula da Silva was jailed for corruption earlier this year.




Mr Bolsonaro won over part of the business community with his one decisive act on economic policy — the choice of Mr Guedes, a tough-talking champion of liberal reform.

“This may be the first time we have a real chance of having capitalism in Brazil,” says Alfredo Valladão, a Brazilian political scientist at Sciences Po in Paris.

Supporters hope Brazil can re-emerge as one of the world’s most dynamic large economies, with some economists predicting it may grow faster in 2019 for the first time in six years than Mexico, Latin America’s other large economy, which is shifting left under new president Andrés Manuel López Obrador.

Balanced against these hopes, however, are questions over whether Mr Bolsonaro has the political skill to deliver such a transformation. His coarse rhetoric may please loyalists on the far right, but his ability to negotiate proposed reforms with the 30 parties in Brazil’s fractious congress or to deal with tough trade partners, such as China and the US, is untested.

Critics say he did not help pass a significant bill during his decades as a lawmaker — during which time he regularly voted with the left to defend the interventionist policies and special privileges he now criticises.

“The question is much more about the political capacity of the government to execute and define priorities than about the technical agenda,” says Marcos de Barros Lisboa, an economist and president of the Insper business school in São Paulo.


For Kevin Gibson, Latin America chief executive of recruitment consultancy Robert Walters, the change in economic sentiment after the election victory of Mr Bolsonaro has been immediate. Businesses have suddenly begun trying to recruit again after a long hiatus. “Companies believe the opportunities for growth are now far better and they want to beat the rush for talent,” he says.

After the economic disaster of the former PT government, which presided over a collapse in gross domestic product of more than 7 percentage points between 2015 and 2016, big business was eager for a change, analysts say.

Mr Bolsonaro has public support too. According to a survey by polling company Ibope, 64 per cent of Brazilians believe his government will be “good” or “great”.

In his favour is a cyclical economic recovery. Analysts surveyed by the central bank are predicting growth in gross domestic product of 1.3 per cent this year and 2.5 per cent next year. Inflation and the central bank’s benchmark Selic interest rate are subdued.

“We already have a cyclical recovery under way, inflation is low, the Selic is low and credit is recuperating,” says Leonardo Fonseca, chief economist at Credit Suisse in São Paulo.

These tailwinds are creating the conditions to tackle Brazil’s fundamental challenges — its ballooning fiscal bill and its excessive bureaucracy and taxes. The government’s budget deficit in 2018 was about 7 per cent, the central bank says. This has raised gross public debt to 76.3 per cent — high for a developing country, particularly one with Brazil’s history of elevated interest rates.

The pension system allows many people to retire in their mid-50s, especially career public servants. Last year, pension expenditure consumed a third of the government budget.



The unpopular outgoing government of Michel Temer, which took office after the 2016 impeachment of president Dilma Rousseff, was unable to get even a watered down pension reform through congress.

With his greater political capital, Mr Bolsonaro should be able to pass at least Mr Temer’s diluted reform, which sets a minimum retirement age for urban male workers of 65 years old and women of 62 years old, analysts say.

However, the military and police, his main constituents, would likely oppose a stronger reform, which would impact their own generous retirement systems. He would also need a constitutional majority of three-fifths of the lower house of congress to pass the measures.

Other ambitious reforms include a long list of proposed privatisations, streamlining the tax regime and opening up the economy by lowering tariffs.

“The argument usually used is that we need first to modernise the economy to be competitive then to open up,” says Mr Langoni. “I would say the opposite, we need to first open up to be competitive.”

If the pension reform passes, companies may start to feel confident about investing again as they would have less reason to fear that high government debt levels would be met with increased inflation. Most equity strategists expect the Ibovespa stock index to rally too.

“We see greater room for Brazil to keep surprising to the upside and for Mexico to behave in an opposite fashion,” says UBS Global Wealth Management in a note.



Mr Guedes, a 69-year-old native of Rio de Janeiro, describes his partnership with Mr Bolsonaro by referring to the words “Order and Progress”, which are written on the Brazilian flag. In Mr Guedes’ telling, Mr Bolsonaro represents “order” and the financier “progress”.

Mr Guedes has made market-friendly appointments, including fellow University of Chicago alumni Roberto Castello Branco as head of state-owned oil company Petrobras and Joaquim Levy, a former finance minister, as head of Brazil’s influential development bank BNDES. Rogério Marinho, an experienced congressmen, was appointed special secretary for social welfare.

“The latest appointments in the ministries have been very good,” says Insper’s Mr Lisboa.

However, there are a series of risks facing the new government. They start with Mr Guedes himself. He is under investigation over suspected fraud in dealings with state-owned pension funds — allegations he has dismissed.

Mr Guedes could also fall out with his tempestuous boss. Mr Bolsonaro will come under intense pressure from erstwhile allies when he introduces pension and other reforms. Oxford Economics says the second biggest “downside risk” for Latin America after a China slowdown is the possibility that “Bolsonaro fires his orthodox finance minister and fails to deliver on his promised economic reforms”.

The other risk is political. Mr Bolsonaro is pursuing a different way of doing politics in Brasília. Instead of allotting ministries among allied parties in congress, he has largely appointed technocrats and retired military officers to his cabinet. He is also wooing individual congressmen directly, analysts say, rather than negotiating with party leaders, who still wield power because of their control of election funds.

If congress turns hostile, Mr Bolsonaro could go “full Caesar” and appeal directly to the people via social media on important reforms, says Matias Spektor, a professor of international relations at the Getúlio Vargas Foundation. But this would be a fraught strategy. “It’s very unlikely that the people will take to the streets to put pressure on lawmakers because the reforms, particularly pensions, are deeply unpopular,” says Mr Spektor.

Corruption scandals are another emerging risk — especially given the role that the backlash against graft played in electing Mr Bolsonaro.

Prosecutors are investigating the finances of a former driver of one of Mr Bolsonaro’s sons, Flávio, who was elected to the senate this year, after it was revealed that large sums of money had passed through the driver’s account that had little relation to his income.

The Bolsonaros have denied responsibility. Onyx Lorenzoni, Mr Bolsonaro’s chief of staff, is also under investigation over receiving illegal campaign payments.



Another risk is the adherence of Mr Bolsonaro, his sons and some of his ministers to sometimes obscure rightwing and Christian ideas. Mr Bolsonaro has appointed as foreign minister Ernesto Araújo, a mid-level diplomat and Donald Trump fan who once described John Lennon’s song “Imagine” as “both the anthem of economic hyper-globalisation and the hymn of Marxism in its communist ‘dream’”.

The new government is re-orienting foreign policy towards Israel and the US and away from the Arab Middle East and China, which are major trading partners, without receiving any apparent concessions in return, analysts say.

The strategies are already exposing rifts in the new government between the ideologues and the pragmatists.

“Our relationship with either the US or with China has to be one of a global player,” says Mr Bolsonaro’s vice-president-elect, retired general Hamilton Mourão, who is emerging as one of the more cautious voices in the new government. “There has to be mutual benefits in this relationship.”

On other foreign policy issues too, the incoming administration is making what analysts call “mistake after mistake”. The president-elect is scepticalon climate change and the environment. His pandering to rural lobbies, which want to open lands belonging to indigenous and traditional communities to agriculture, could compromise the international reputation of Brazil’s soyabean and meat exports, analysts say. Foreign farmers could use deforestation to pressure their governments to block Brazilian exports.

“It’s almost childish, a very simplistic way to move internationally,” says Michael Freitas Mohallem, a professor at law school FGV Direito Rio.

For now, markets are treating these controversies as the teething problems of a new administration. Whatever its ideological whims might be, say economists, it will have no choice but to pursue market-oriented reforms.

But with expectations sky high, Mr Bolsonaro will need to deliver — or his administration’s honeymoon with both voters and markets will be shortlived.

New president keen to side with the US and other nationalist leaders

Ernesto Araújo, Jair Bolsonaro’s crusading incoming foreign minister, seems poised to upend Brazil’s longstanding tradition of consensual “rainbow” diplomacy. He has called climate change a Marxist plot, bemoaned the leftist “criminalisation” of red meat, fossil fuels and Disney movies, and wants to leave the global pact on immigration.

“We’re not in the world to be Miss Congeniality,” he wrote in an article cited by the Folha de S.Paulo newspaper.

His thesis is that Brazil needs to side with US President Donald Trump and, among others, the Hungary of Viktor Orban and the Italy of Matteo Salvini. He would also like to create a “nucleus composed of the three largest Christian countries, Brazil-US-Russia”.

Mr Araújo also wants to impose “pressures on all fronts” on China. How this would work is unclear, as the trade war started by Mr Trump has made Brazil increasingly dependent on China, which now accounts for about one-quarter of all Brazilian exports; the US ranks second, receiving 12 per cent of its total exports.

“Instead of taking advantage of the trade war between Washington and Beijing, Mr Araújo is playing with the fantasy of a holy anti-China alliance whose only concrete result will be to have Beijing play its diplomatic weight against Bolsonaro,” says Matías Spektor of the Getúlio Vargas Foundation.

Eduardo Bolsonaro, the gun-loving congressman and son of Brazil’s president-elect, is working to reshape the country’s foreign policy alongside Mr Araújo. Last month he visited Washington, where he met Jared Kushner, Mr Trump’s son-in-law and senior adviser, and was seen sporting a “Trump 2020” cap.

When leftist Dilma Rousseff was sworn in four years ago for a second term, former US vice-president Joe Biden was in attendance. Despite Mr Bolsonaro’s efforts, neither Mr Trump nor his vice-president Mike Pence will attend his inauguration on January 1.


December was best month for global bonds in more than a year

Safest fixed-income assets turned positive for the year as economic clouds gathered

Robin Wigglesworth in New York


© AFP


Global bond markets enjoyed their best month in more than a year in December, as rising concerns over the health of theglobal economy sent investors in search of relatively safe assets.

The Santa Claus rally that was missing from equity markets was in full swing in fixed income, bringing some respite to battered debt investors.

The global bond market has been under intense pressure for most of 2018, as economic growth fanned fears of inflation. The Federal Reserve kept raising US interest rates and shrinking its balance sheet, and the European Central Bank trimmed and ultimately ended its own bond-buying programme.

As a result, by mid-November the Bloomberg Barclays Multiverse index, a broad gauge covering $53tn worth of government and corporate debt around the world, was nursing a 3.7 per cent loss for the year. Although modest compared to the decline in some equity markets, that put the global bond benchmark on track for its worst year in more than a decade, and US bonds were heading for their worst year since 1994.

However, the equity market ructions and fading optimism over the international economic growth outlook for 2019 sent investors scrambling back into the safety of fixed income, lifting the Multiverse index by 1.7 per cent in December. That is its best monthly gain since July 2017, and pared its loss for the year to 1.6 per cent.



“The US economy is slowing, and will likely continue to slow as this long growth cycle simply runs out of gas,” said Kevin Giddis, head of fixed income at Raymond James. “The Fed will be on hold for the foreseeable future. They may not tighten at all in 2019, and may even ease if conditions deteriorate from here.”

Underscoring the rising doubts over the economy and mounting expectations that the Fed will have to ease back on its monetary tightening plans, the global bond market bounce has been powered by the safest bonds.

The yield on 10-year US Treasury bonds has dipped from a seven-year high of 3.26 per cent in early November and on New Year’s eve it fell below 2.7 per cent for the first time since February, to end the year at 2.68 per cent. That helped the overall US government bond market to a 1.9 per cent gain in December, the best in almost two years. Yields fall as bond prices rise.

Higher-rated European and Asian government debt, as well as US municipal bonds, have also rallied from their lows, helping produce annual gains for those markets as well.



Mr Giddis believes that “unless something radical occurs”, slower growth, political gridlock in Washington and still-subdued inflation will push the 10-year Treasury yield further down to 2.25 per cent in 2019.

However, corporate debt has remained under pressure, especially bonds rated below investment grade by the major credit rating agencies, commonly called “junk” or high-yield bonds.

The Bloomberg Barclays Global High Yield index has lost 4.2 per cent this year, its worst performance since the financial crisis and only the fourth annual loss since at least 1990. Investment grade corporate debt also managed to pare losses in December, but still notched up a 3.3 per cent decline in 2018.

Scott Minerd, chief investment officer at Guggenheim, sees riskier assets, such as equities and corporate bonds, remaining unloved.

“The past month has provided not just a meteor or two but a virtual storm,” Mr Minerd said. “No doubt there is more volatility to come and, with holiday-dampened liquidity, I don’t see many investors willing to step in to buy — especially given that so many were caught offside.”


The Second Partition of Ukraine?

The country lost part of its territory nearly five years ago. Was that just the beginning?

By Jacob L. Shapiro 


In the 18th century, the once-mighty Polish-Lithuanian Commonwealth collapsed, ending an empire that, just a century prior, had been the most populous entity in Europe. After 100 years of war, corruption and sclerotic rule, it was dismembered over 23 years by three of its neighboring rivals – the Russian Empire, Prussia and Habsburg Austria. Present-day Poland still bears the scars of those partitions. For another 200 years after its division, Poles were deprived of their autonomy, which was only regained following the collapse of the Soviet Union. Those years of subjugation remain the driving force behind Polish national strategy today. While Austria no longer poses a risk, Russia and Germany are the biggest threats to Poland’s independence and prosperity.




        


You may be wondering what any of this has to do with Ukraine. The answer is, Ukraine is in danger of experiencing disintegration similar to what Poland endured in the 18th century. In fact, Poland is one of a number of regional rivals that have claims to Ukrainian territory and may be waiting for an opportunity to take back what they see as rightfully theirs. Poland’s own dismemberment hasn’t prevented the emergence of a nascent Polish revanchism, and the same can be said to varying degrees of Hungary, Romania and, most notably, Russia. Caught between these stronger powers, beset with acute internal political fractiousness, bereft of significant military force and governed by a corrupt and well-entrenched oligarchic class, Ukraine is a ticking time-bomb, and it’s becoming increasingly uncertain whether anyone is willing or able to defuse it.
 
Underlying Problems
Ukraine’s fragility has been widely overlooked. The narrative in the Western media narrative around Ukraine has been shaped mainly by a combination of understandable, if hysterical, fears in Ukraine about Russian domination and an intense anti-Russia bias. Just last week, the Institute for the Study of War, a resource we’ve occasionally cited in our own work, published a report predicting possible imminent Russian “offensive operations against Ukraine from the Crimean Peninsula and the east.” The evidence for a Russian offensive includes the movement of a few military convoys, a few Foreign Ministry statements, a planned naval drill in the Black Sea and the transfer of “more than a dozen” fighter jets to a base near Sevastopol. Taken together, these moves might well give the impression that Russia is preparing for an operation in eastern Ukraine. But the reality is more complicated. And the underlying problems in Ukraine are more serious than the threat of a limited Russian incursion.

Internally, Ukraine is facing a number of challenges. Its gross domestic product dropped by 17 percent in the two years following the 2014 revolution, Russia’s subsequent seizure of Crimea and insurgencies in Luhansk and Donetsk. Sensing an opportunity to pull Ukraine further into the Western camp, the International Monetary Fund in 2015 approved a $17.5 billion loan over four years to help boost Ukraine’s economy. It took roughly two years and a dispersal of about half the total amount for the IMF and its Western backers to become dissatisfied with how Ukraine was spending the money and suspend the loan. (The IMF agreed to a new $3.9 billion program with Ukraine just last week.) Then-U.S. Vice President Joe Biden even said the U.S. might have to abandon sanctions against Russia if Ukraine couldn’t overcome its corruption problems. He might as well have asked the sky to stop being blue.

Ukraine has taken some small steps in recent months to satisfy its creditors. Fearful of what the IMF might do if Kiev didn’t at least appear to be meeting the obligations of its loan program, it followed through on a promise to raise gas prices by almost 25 percent in October. Ukraine was in danger of a serious liquidity crisis – in July, it had to delay pension and public sector salary payments – and without more IMF funding, it might have been unable to meet its debt payments and finance its budget. This is the cost of keeping Ukraine in the pro-West camp and why Russia feels less urgency than most think it does to reverse the outcome of the 2014 revolution. It’s happy enough to wait for Ukraine to revert to a more neutral position while the West grows tired of footing the bill for its recovery.

The situation will only get worse in the year ahead. In 2019, Russia will complete work on the TurkStream and Nordstream 2 pipelines, which will enable Russian natural gas exports destined for Europe to bypass Ukraine and slash Ukrainian revenue from delivery of these exports through its territory. (Last year, Ukraine earned roughly $3 billion in transit fees from Russian gas exports to Europe – no chump change for a country on the edge of a liquidity crisis.) In March, Ukraine will hold its first presidential election since the 2014 Maidan Revolution. Due to its struggling economy, social divisions and competition between political factions with conflicting business interests and personal allegiances, no single candidate has even 25 percent of the vote so far. Russia’s main concern, therefore, is not a pro-Western government in Kiev but that chaos following the election could cause volatility on the Russian border.
 
External Issues
Ukraine also has several external problems, chief among them being Russia. Russia doesn’t want instability in Ukraine any more than the United States or any other Western country does – but it’s more affected by economic uncertainty and political competition in Ukraine than the other outside powers involved in the frozen conflict there. And while Russia isn’t exactly a 21st-century incarnation of the Soviet Union – Moscow isn’t peddling a global ideology and has no delusions that it can compete as an equal with Washington on the world stage – the Russian government has relied heavily on Russian nationalism to legitimize its rule. And its brand of nationalism requires Moscow to protect Russians wherever they live – including in eastern Ukraine. Vladimir Putin’s government can’t abandon the ethnic Russian population there without looking weak.

There’s no doubt Russia has beefed up its military presence on its western border and is increasingly active in the Black Sea, but these are more signs of Moscow preparing for a meltdown in Ukraine than precursors to an invasion. Russia has wanted relief from U.S. and EU sanctions for years, and it behooves Russia not to antagonize the West but to find some kind of accommodation (especially with a potential global recession and possibly lower oil prices approaching). But to do so, it can’t be seen as the aggressor in a conflict with Ukraine – and Ukraine knows it, which is why Kiev made such a big deal out of the Kerch Strait incident, a relatively minor affair, all things considered. There are some in the Russian establishment who want to make up for the embarrassment of losing Kiev in 2014, and perhaps even some who think a show of force in eastern Ukraine might distract Russians from their own financial woes. But it’s more likely that Russia is preparing for any eventuality, including a possible internal collapse in Ukraine – and, meanwhile, is biding its time.


 
Russia, however, isn’t the only country eyeing Ukrainian territory. Hungary has long wanted to reabsorb parts of western Ukraine that still have a majority ethnic Hungarian population. Similarly, Moldova and Romania both have claims to Ukrainian territory along their borders, though they have been less vocal about their grievances than the Hungarians. (For its part, Romania doesn’t want to jeopardize its close relationship with the United States by compounding Ukraine’s problems. Washington barely pretends to care about Ukraine and certainly doesn’t want to get involved in squabbling over post-World War II territorial claims, especially if such squabbling could make blocking Russian ambitions in the region even costlier.)

Poland, too, has had political disputes with Ukraine. The ethnic Polish population in Ukraine was less concentrated after World War II than the ethnic Hungarians and Romanians, so it’s harder to point to a specific area that Poland wants back. But Poland once held much of the territory now in western Ukraine. Present-day Lviv was once a powerful Polish city called Lwow – almost 60 percent of the city’s population in 1944 was Polish. But just six years later, Ukrainians had become the largest ethnic group in Lviv and today represent more than 90 percent of the population. Poland is an emerging power in Eastern Europe, but its power has limits. Its curse is that it’s located on the North European Plain, but in times of strength, that curse becomes a temptation. Indeed, Polish influence and economic ties in western Ukraine have been growing. And although most Poles don’t think in these terms, the stronger Poland is, the more its influence is felt in the region, especially in Ukraine.

Ukraine is facing a number of serious internal and external challenges. Internally, a corrupt, oligarchic ruling class is presiding over a crisis-prone economy dependent on outside aid to remain afloat. Elections are upcoming, and if the polls and previous elections are any indication, they could once again stir up discontent in the country. Russia, meanwhile, is preparing for a time when it may need to intervene in Ukraine to secure its interests and protect ethnic Russians living beyond its border. Others are waiting in the wings for an opportunity to settle old scores and redraw borders while keeping Russia sufficiently at bay. None of this is yet inevitable, but the forces threatening to tear Ukraine apart are very real. Considering the history of the region – including the loss of Crimea nearly five years ago – it’s reasonable to ask whether Ukraine stands on the precipice of a second partition.


Sell Stocks Before The Corporate Debt Bubble Bursts

by: Global Opportunities Analys


Summary
 
- Corporations have piled on record amounts of debt to buy stocks.
       
- Recently their investment in stocks has turned sour while their debt burden has just started feeling heavier.
       
- Corporate executives will likely cut back on share purchases, and this in itself is bad news for the future.
       
- Add to the above the fact that the economy is slowing and executives expect recession, and stock investors become even rarer. 

       
It was just on December 15th when I argued that the S&P 500 was "likely to crash deep below 2.600", and a few days ago that I wrote that it was a good time to buy stocks as the S&P 500 was around 2.400. My buy recommendation was for a relatively short period of time. The market has since bounced back nicely. Things have been moving dramatically, and the US stock market of the past couple of weeks has behaved nothing short of extraordinary. You don't see such movements every year, and there have been many decades without such sudden market crashes in the US. These times have also been great opportunities for making good profits from short-term trading, though obviously extremely few people are able, or willing, to enter such trades involving gut wrenching volatility.
 
Now that the market has recovered quite a bit I believe it is time to start looking at the truly bad fundamentals and position for the coming year. And I believe, as I also mentioned in my last article, that 2019 will be a bad year for risk assets, particularly for stocks. It is not very wise to stay invested until the economy starts showing significant signs of weakness. But early signs of weakness are already there, as housing, and the economy in general, have started to lose steam in recent months.
 
These weaknesses are likely to get worse as the economic cycle moves along its already historically long lifespan. There are some serious concerns out there, which actually led to the crash we had from October to December. Let's start from perhaps the most immediate and important concern - the corporate debt bubble. Most people talk about the trade war with China, or the Fed rate hikes, but the fact is that a strong economy can withstand such challenges. The real risk, and the real fear of the market, is growth, or the lack of it.
What led to the financial crisis of 2008? Most would agree that, ultimately, it was about easy money. Easy money pushed capital toward wasteful investments which eventually popped and caused a massive crash. The major wasteful investment that popped back in 2008 was real estate. What happened after 2008? As everybody knows, money got even cheaper. Central banks in the whole world cut interest rates and took other monetary measures (such as QE) in order to tackle the dire economic consequences of the crash of 2008. Central bank rates are currently, still, below zero in Europe and Japan.
 
With hindsight, we know what was the major wasteful investment before 2008. What few agree upon though is about the wasteful investments afterwards. Very few before 2008 thought that investing in real estate could ever blow up in their faces, let alone cause a global financial meltdown. Since many economists and politicians thought that it was improper banking regulation that led to the 2008 crash - rather than too low interest rates - they believe that we are going to be just fine this time around because there have been significant changes, and improvements, to banking regulations. And they believe this will prevent another financial crisis, or at least one as bad as 2008. It is indeed unlikely we will get exactly the same kind of crisis we had last time, but cheap money has, again, and on a much larger scale, pushed capital into risky, speculative, and wasteful investments. And wasteful investments always blow up, sooner or later. I believe that wasteful investments have been aplenty in the years since the financial crisis of 2008. One popular case is China, where zombie corporations, and ghost towns, have been spreading in recent years. Of course there are too many areas of wasteful investments, all around the world (not just in China), and even real estate is not far from what it used to be before the 2008 crash. Many real estate markets are again overvalued and there is a lot of building going on which can, again, go bad. But I'm going to focus more on the US corporate debt problem, which it seems, is in a more immediate danger than other bubbly areas of the world economy. And since money has been much cheaper, for longer, I don't see why a potential future crisis would not be much bigger, and a lot more complicated (perhaps even impossible) to contain than the crisis we had a decade ago. Let's not forget that the world's central banks no longer can cut interest rates by 500 basis points (5%) as the Fed did last time (or in earlier recessions), which led to a rather quick recovery in asset prices. The absence of this monetary tool is probably the greatest of worries economists, and investors alike, should think about.

What first comes to my mind about the consequences of cheap money, which could blow up much sooner than many think, is the corporate debt bubble in the US. US corporations are carrying more than $9 trillion in debt. The share of non-financial corporate debt to GDP is at record levels, higher than its inflated levels during the 2008 financial crisis (chart below).
 
 
 
But the most important issue is not the size of the US corporate debt, but what most of that debt has gone to, which is alarming. This year alone US corporations are supposed to have spent $1 trillion in share buybacks (chart below).
 
 
 
Corporations have massively borrowed money to buy back their own shares. Why have they done so on such a scale? They thought interest rates are not going to stay low for too long, and that the low interest rate environment is a rare and extraordinary occasion they have to take advantage of. The belief that inflation, and interest rates, were going to rise over the coming years was almost unanimous up until a month ago. However I argued back in June that longer duration interest rates would likely go lower. My belief was almost seen as equal to madness.
 
Up until a month ago it seemed like there was competition among economists, business executives and investors, on who would predict higher interest rates for the coming quarters, or perhaps couple of years. Back in August one of the most respected US executives, JP Morgan CEO Jamie Dimon, not content with his previous prediction of 4% longer-term interest rates, went even further and predicted a 5% yield for the US 10-year treasury. Such beliefs offered motivation to borrow as much as possible, as early as possible. Interest rates did go up for a while this year - as bearish bets against long-term US treasuries reached record levels - but they have been falling quite sharply in recent weeks. US corporations piled on debt to buy back their shares and those trillions of dollars pushed their stock prices to record levels. What happens now that some corporate executives are beginning to see a major flaw in what they believed - that interest rates aren't exactly going up? Does all that debt used for buying shares get riskier, and cheaper, than it used to be? Corporate bonds have already started feeling the heat.
 
What happens if it is not only the interest rates not going up, but also stock prices going down because the Fed just raised its benchmark rates again while the economy softened? And this is what just happened for the past couple of weeks. Corporations have used longer duration debt, bearing interest ranging usually between 3 to 6 percent, to buy back their own shares (or other companies' shares in mergers and acquisitions) in the belief that higher inflation will take care of most of their debt burden. If inflation is low (and interest rates are also very low, historically), and you get a 10-year loan with fixed (low) interest, and then inflation rises, this makes your loan a nice deal as inflation erodes your debt and makes repayment much easier.
 
This is what most companies binging on debt were thinking of. They are now starting to fear they may have been wrong. However the fear is not really strong yet, and it has a lot more room to spread and become rather mainstream.
 
Corporate executives didn't believe inflation could stall, or perhaps fall in the following years.
 
As US longer duration treasury yields show, bond investors believe that inflation is not going to rise any time soon. The 10-year US treasury is yielding around 2.7%, which is just slightly higher than the Fed overnight rate of 2.5%. And the data are showing that inflation is not rising above the 2% target of the Fed but it is rather showing signs of slowing.
 

The recent stock market selloff was a warning sign, first of all, for all the companies which have piled on debt to buy shares. I think the market has started to scare them, and they will most likely cut back on share purchases on borrowed money. This action alone can cause further weakness in the stock market. If you spend trillions of dollars in buying back your own shares, and you see the stock price crash - as they just did - it makes you think more carefully about future buybacks. This is beside the fact that a slowing economy, without higher inflation, is making their debt-laden balance sheets more vulnerable. Not many executives are panicking yet, but they might start soon. After all, the market is still a lot higher than it was just a couple of years ago, and this often justifies some smart panicking. It is also reasonable to expect not so many share buybacks next year based on the serious pessimism permeating US executive scene for 2019 and 2020. According to a study recently published, 80% of American CFOs believe recession will hit by 2020 (and almost half expect recession by 2019). Why would they, rationally, invest in share buybacks now?
 
Nevertheless so far not many are fretting about the dangers that all the trillions spent on share purchases, either in buybacks or in mergers and acquisitions, can pose to corporate balance sheets in an unfriendly market environment and how it can cause panic and a serious crisis, in sectors we can consider completely unrelated. After all, the 2008 crisis started from real estate and spread to all corners of the economy, and to all the trading partners of the US, which had nothing to do with real estate speculation. This is why I believe it is a good idea now to sell and just stay opportunistic. A corporate debt panic in the US can cause a lot of damage and it would not be contained easily. The crash of 1929 was mostly caused by stock market speculation on margin - meaning borrowed money.
 
It is true that we do not have exactly the same situation now, as companies are not involved in short-term speculation of share prices. Nonetheless, fundamentally speaking, it is still called stock market speculation on borrowed money, though the time horizon of the speculators is longer now than it was in the late 1920s. Corporate executives have been speculating on their share prices, and they have been doing so with borrowed money. Corporation will not be forced to dump the shares they have bought, as retail speculators did back in 1929 after margin calls, but corporations can face serious difficulty with their record debt levels. Corporate 'margin calls' can occur when their bonds get dumped and they can no longer refinance. Corporations may soon face the reality of having squandered trillions of dollars on share prices which have crashed. In case inflation goes much lower, and US treasury yields fall further, corporate debt repayment will become impossible for many companies. And this thought has just turned into a real possibility with the recent stock market crash associated with a sharp fall in US treasuries (chart below).
 
 
Maybe the market goes up a little bit more, or maybe it stays around current levels for a while.
 
But the future, especially next year, looks very risky, and not worth investing in risk assets, especially when you can still buy US treasuries which yield more than 2.5% and carry no risk.