By Haddon Libby
Last week, economists concluded that the Federal Reserve will need to reduce the Fed Funds rate by at least 0.5% to 2% by year-end marking a dramatic shift in Federal Reserve thinking as it relates to interest rates. Recent slowness emerging in the US economy along with the looming impact from tariffs caused the group conclusion that rate decreases were necessary to stave off a recession. This is reflected in the markets by an inverted yield curve on US Treasuries. Stated in English, this means that borrowers pay less when they borrow for a long time (i.e. mortgage) versus those who are borrowing for a shorter time period (i.e. line of credit). This is the reverse of how things normally work and has predicted past recessions with 100% accuracy. Add to this falling oil prices and increased gold prices despite a lack of inflation and one can conclude that the stock and bond markets view current geopolitical issues with China with great concern. While stock markets might continue to do well for a while, the inverted yield curve is a strong indicator of harder times ahead.
With this as a backdrop, one of the best investment managers of the last thirty years, Stanley Druckenmiller, said this about the inevitable reduction in interest rates while on CNBC last week, “…a hurdle rate for investment (should be) up there around 3-4% (or) people are going to get crazy…investors are going to get crazy, corporations are going to get crazy, zombies are going to stay in business.”
The problem with low interest rates is that people, companies and governments use debt for things that would normally be funded with equity or discontinued due to poor returns. Zombies companies, governments like Italy or high-flyers like Tesla get funding when each would otherwise go bankrupt due to poor performance or excessive debt.
What makes things even more topsy turvy is that we have some of the lowest interest rates in the history of the world despite the highest debt levels in history.
According to the Institute of International Finance in Paris, the world had $243 trillion in debt outstanding the end of 2018 (and 7.7 billion people) or $31,558 per person. 88% of the world’s $3.3 trillion in debt increases occurred in the United States where total debt now stands at $68 trillion (330 million people). Despite the best economy in fifty years, the United States put on the most debt in one year since 2007, the year the Great Recession hit. Global debt equals 3 years of Global Domestic Product (GDP).
These numbers make it clear that debt issued in 2018 served to spur the U.S. economy at a time when the E.U. and China were slowing. Between less government deficit spending and the cost of tariffs, the world economy will slow in 2019 with many parts falling into recession.
Complicating the resolution of trade talks with China is the need to slow or stop their corporate and government espionage. Whether it is espionage chips found in the motherboards computers made in China and used by the U.S. government and much of business, the Chinese government has used cheap Chinese goods as the method by which they spy on those with information that they need.
The real battle going on between China and the United States is not about tariffs but an effort to fight the spread of Huawei chips and other espionage tools into new 5G and A.I. infrastructures globally. As Huawei has direct links to the Chinese military, the real concern of the Trump Administration relates to China’s ability to steal future technological breakthroughs with ease if they control the devices running these global systems.
While an end to trade issues would help the global economy in the near-term, it could lead to longer term and far larger problems if China is able to steal and cheat at will.
Haddon Libby is the Founder and Managing Partner of Winslow Drake Investment Management. Less than 1 in 20 investment management practices perform to the Fiduciary Standard of Care in everything that they do. We are one of them. Learn about the difference by dropping me a note at HLibby@WinslowDrake.com. For more information, please visit www.WinslowDrake.com.