Investors need to be mindful of economic risks that were ignored before the dot-com and subprime bubbles collapsed and triggered recessions, said Doug Kass, president of Seabreeze Partners Management Inc.
Unsustainable borrowing, this time from governments, will come back to haunt the global economy, he says, pointing to Japan’s negative interest rates as an example of the latest market mania.
“Thanks to the same kind of stupidity that prompted investors to buy housing derivatives a decade ago, Japan is still able to sell 10-year bonds that carry negative interest rates,” Kass writes on his RealMoneyPro blog
. “The current mess is even worse in some ways than the last one because negative interest rates virtually guarantee that those who hold Japanese government bonds will lose money.”
The Bank of Japan in January adopted negative interest rates for the first time, charging financial institutions for parking certain kinds of reserves at the central bank. The policy was intended to encourage lending, but backfired as stocks sank, consumer spending dried up and savers sought the safety of cash holdings.
“The size of today's bubble is also even larger than it was the last time around,” Kass says. “There are more than $7 trillion of government bonds with negative interest rates out there, which vastly exceeds the size of the derivatives that nearly bankrupted the world's financial system nearly a decade ago.”
The American economy has several characteristics that remind him of the 2008 financial crisis, when investment bank Lehman Brothers Holdings Inc. collapsed in the biggest bankruptcy of all time. The crisis followed the 2006 peak of the U.S. housing bubble that was fueled by reckless bank lending.
The Fed responded to the last crisis by cutting interest rates to a record low of near zero percent
, and undertaking trillion-dollar bond-buying programs that were intended to keep rates low. Whether the central bank has the monetary tools to cope with the next recession is a subject for debate.
“In 2006, the underlying belief was that U.S. home prices would never fall on a year-over-year basis — a view that turned out to be wrong,” Kass says. “A decade later, we're told that governments can simply print their way to prosperity and we can consume more than we produce because no amount of debt will deter economic growth. But I believe that's wrong, too.”
Doug Kass’s Warning Signs:
- U.S. government debt totals about $19 trillion, or some $11 trillion more than it was in 2008.
- The Federal Reserve's balance sheet is approaching $5 trillion versus $800 billion in 2008.
- Short-term interest rates are 0.25 percent compared with 4.5 percent back in the day. With interest rates at near-record lows, there's little opportunity for the Fed to further expand its balance sheet.
- The derivatives market is currently larger than $500 trillion versus $182 trillion in 2008.
- Central-bank capital has dropped to 0.8 percent of assets from 4.5 percent.
- The size of the subprime bubble was $1.3 trillion, but the size of sovereign borrowing is $7 trillion today.
- Our government has to borrow money to simply pay interest, and monetary policy is hamstrung by near-zero interest rates.
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