2016: What Was And a Preview of 2017 2016-12-26 09:18
"Let me remind you how this crank-turning has worked for the last 30 years, since people have short memories and I've only written a dozen or more Tickers on this, say much less the chapter in Leverage on same.
30 years ago you borrowed $1 million. The interest rate was 10%. You needed $100,000 a year in income to pay the interest coupon. Governments and businesses never, ever, pay off those bonds -- they roll them over endlessly when they mature. If you doubt this then go look at both corporate and government debt on the Fed Z1; neither has ever decreased by one dime, even during the 2007-2009 crash.
Ok, so then rates drop over time to 5%. You could take that windfall of $50,000 in interest payments saved every year when your bonds are rolled and spend it somewhere. But $50,000 is small ball because it will take 20 years for that savings to amount to a million bucks. The alternative is that you can choose to keep paying $100,000 a year in interest but borrow another million and spend it right now.Guess what business and government did? Now you have another million to "spread around", whether it makes your P/E better, is handed out in social spending or whatever.
Rates continued to fall. Over time they fell until just recently good credits in the corporate and government space could borrow for several years at rates of 1%! So they did. Now it's not $1 or $2 million that's out and has been spent it's $10 million, with the same $100,000 interest payment due.
But what happens if the rate goes up just 1% from there -- to 2%?
Now you have a big problem. You either need to come up with $5 million in cash to retire half the bonds when they roll, since you only have $100,000 for interest payments or you're (expletive deleted). In the corporate sphere you can no longer "turn the crank" of leverage to goose "earnings", fund buybacks of shares and similar -- you now not only have rapidly increasing interest expense you can't borrow any more money because you can't pay the coupon on it given your current level of indebtedness.