Welcome to the 01-23-2018 update from your Pocono Summit Certified Financial Planner and retirement planner, Mike Savage. Today, Mike discusses smoke screens of solvency in the financial world, and the difference between good debt and bad debt.
I have written many times that I believe that the downfall of the latest rally in the stock market would likely begin in the bond market.
While central banks around the globe appear to have an unlimited amount of “money” that they can keystroke into existence, at virtually any time they want, we have to remember that all of this “money” is in the form of debt. The world only has a certain capacity to carry that debt.
Actually, we blew right past that capacity in 2008 and only by adding larger sums of debt have we been able to keep the illusion of solvency alive. Since 2008 central banks have “printed” over $100 trillion and this “money” has been used to purchase assets outright- raising prices by supplying artificial demand mainly in the stock, bond and real estate markets.
By first buying sovereign bonds they made interest rates artificially low. This made it easier for governments to continue to add more debt and continue to pay the interest as old higher interest debt was rolled over into lower interest rate debt. Companies were able to get ultra low rate loans and purchase their own stock back. Many regular people were able to buy homes, autos, etc. that they could not likely afford if interest rates were at normal levels.
Banks and hedge funds have used the virtually free money to add to their speculative positions and leverage their positions for increased gains- as long as the markets keep rising.
While the central banks just may bail out the Federal governments it is far harder to bail out states- many which are struggling under the weight of crushing debts and underfunded pensions as we speak.
Companies that have raised debt, paid dividends out and bought their stock back with the proceeds are, to me, a classic case of issuing bad debt. A bad debt is a debt that is used for consumption and does not provide an income stream to one day retire the debt.
With a good debt you would issue debt that would have a plan for an income stream to retire that debt and in the end you are left with an asset that is unencumbered by any liability. Any income is yours to keep- minus taxes of course!
I was watching a story about Walt Disney last night and it went into detail about the debt that it took to get Disneyland off the ground. That was a debt that created wealth as opposed to consuming it.
With the type of debt that central banks, federal and state governments are issuing it can be classified as bad debt because the proceeds are being consumed and more and more debt just keeps continually getting piled on. At the end of the day these entities are left with no asset but they still owe the debt.
This is the exact opposite of using a debt to benefit yourself in the future. They are actually spending future expected income today.
Debt is being issued to pay for daily living expenses, contributions to underfunded pensions (making the returns necessary that much harder to hit over time), paying interest on existing debt and paying off old debt with new debt. While I am thankful that many community services are being continued it is not sustainable and could lead to a cliff where benefits may have to be cut off rather than being reduced gradually.
Things are a lot worse than we are being led to believe. Actually, this debt is counted as growth in our GDP numbers. If that doesn’t shed light on how numbers are being artificially reported nothing does.
So why can’t these central banks just keep “printing” ever larger amounts and cover everything? I believe that is a good question. It is because when entities and individuals understand that this is the most likely option (the other is to stop the “printing” and unleash a global deflationary depression) the cat will be out of the bag and everyone will be scrambling to rid themselves of currencies and buy real assets that they can use.
In addition, many cracks in the financial foundation are already appearing. The European Central Bank is buying not only government but corporate debt. Many other central banks are buying stocks, etfs, and other assets.
When (notice I say when- not if) the market corrects it could correct violently. If that happens many companies will see the value of their debt-based purchases plummet but the value of their outstanding debt stay the same. At this time, however, it will be unlikely that they will be able to add more debt at a rate that makes any sense to bail themselves out.
Personally, I believe it is time to get ahead of this. It is time to start looking at commodities, precious metals, etc. as a means of diversifying your assets and wealth. While stocks have been the sexy play for the past few years they are due for a correction.
While everyone has different situations and goals I believe that generally if you have stocks- particularly with nice gains we should let them run to the upside but have a stop-loss order to hedge against major losses.
If you don’t have commodity exposure it may be an asset class to look at as the commodity sector has been out of favor for the past few years. If you don’t have exposure to gold or silver that train may be leaving the station soon. As a matter of fact, gold is quietly up over 20% in the past 24 months.
For 5000 years gold and silver have been used as money. In any new monetary system that may come about it is likely that some asset (probably gold or silver) may be used to reintroduce confidence back into the financial system.
At that point the chance of being able to purchase these assets at a discount will be long gone.
I believe now is the time to get as diversified as possible. I also believe it is better to be a year or two early than a second late.
Mike Savage, ChFC, Financial Advisor
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