Contrary to popular belief, the economy is not healthy. Yes, the stock market is at record highs, but why? Is it because big corporations are more financially sound and profitable? No, quite the opposite; it is nothing but a sugar-high. And the sugar is artificially low-interest rate loans thanks to manipulation by the Federal Reserve Bank. This has set in motion a series of events leading to the collapse of the corporate bond market.
“Why should I care,” you ask? Well, because if corporate bonds go belly-up it might just mean your retirement fund and insurance policies will go with them. Imagine being retired and your retirement check stops coming. Imagine your house burns down but you get no insurance check to rebuild your house.
To understand how we got here we have to understand how the Federal Reserve manipulates interest rates. In a world without the Fed, each bank simply sets its own interest rate for loaning money, in the same way a shoe store sets its price for shoes. If there are a lot of people who want to buy shoes, the store owner can charge a higher price and still sell shoes. If he has too many shoes in his inventory he might drop his prices to entice more people to buy shoes than otherwise would. Banks work the same way. An interest rate is simply the price for borrowing money. If banks have a lot of money to lend, they drop the interest rate to get more people to borrow than otherwise would.
The Fed takes advantage of this to do its manipulation magic. In 1913, when Congress created the Federal Reserve, it gave it permission to counterfeit the dollar. When the Fed wants to lower interest rates it essentially prints billions more dollars and gives them to the biggest banks worldwide. Because these banks suddenly have more dollars, they lower their interest rates to attract more borrowers. But the Fed’s counterfeiting, like any counterfeiting, has consequences. It is the first in a series of tipping dominos.
Domino #2 is corporations borrowing more money than they otherwise would. Since many corporate managers and officers are compensated by stock options, they direct the company to borrow that low-interest-rate money to make more stock buybacks, which artificially increases the stock price. The stock market looks like it’s increasing even though its intrinsic value has not increased. Today, corporations are ignoring the fundamentals of sound business. According to CaseyResearch, 16% of all companies are now “zombies,” meaning they can’t cover their interest payments with existing profits.
Domino #3: The Fed can’t keep interest rates low forever. The counterfeiting would eventually cause runaway inflation, drastically raising the price of everything. Interest rates will have to rise. As they do, zombies’ debt will mature and they’ll have to roll it over to higher interest rate bonds. They can’t afford the higher interest payments and will face bankruptcy. And according to Standard & Poor’s (S&P), $4.5 trillion of corporate debt will mature over the next four years.
Domino #4: Credit rating agencies like Moody’s and S&P will be forced to downgrade those “zombie” corporate bonds from “investment grade” to “junk bond” status.
Domino #5: Retirement plans and insurance companies are not allowed to hold anything but investment-grade bonds. So, they’ll be forced to sell the downgraded bonds on the secondary market.
There will be a flood of junk bond sellers, who might not find buyers. Retirement plans and insurance companies might suddenly find themselves losing massive interest revenue and the cash reserves needed to cover retirement checks and insurance claims.
Yes, the stock market is going up now… just like it did right before the 2007 market crash. And by March 2009 it had lost 54% of that value. History is repeating itself.