One of the great things about getting older is that you remember what didn't happen, and not just what did. You realize that certain stuff was blown way out of proportion while other major events came out of nowhere or went unnoticed for a time. It reminds me of a neat book I once found, "Vanished Kingdoms," which chronicles the states and empires that didn't survive (Aragon, the Rock, etc.), not just the ones that did.
Anyhow, when I saw Brian Reynolds's new note this morning, I immediately had flashbacks to one theme that I thought was going to be huge after the Great Recession but never really gained much traction: the so-called "balance sheet recession." This concept was championed by economist Richard Koo, who wrote a great book about how that contributed to Japan's long malaise after its stock market collapse in 1989.
Koo asserted that Japan was hampered by slow growth for years because its companies were paying down debt to repair their balance sheets instead of investing to maximize future profits. In 2011, Koo argued the entire world could be heading down this path, but it never became a major theme of discussion. I'd venture to say that now, his moment has arrived.
And this is where Mr. Reynolds comes in. He warns, in a note to clients, that the market (specifically, forward Libor) is implying an ever slower recovery next year than what we saw in 2009. "The massive growth in debt and transformation of balance sheets will change the focus of companies to debt buybacks in coming years," he cautions.
The switch to companies minimizing debt--which can also take the form of equity issuance--instead of buying back stock "[will make] for a less intense equity bull market than the last three" that we have experienced, Reynolds says.
There is a larger risk, too. Koo says there are two types of recessions: those triggered by the usual business cycle (which, in retrospect, is what happened in 2008-09), and those triggered by deleveraging/debt minimization. The latter are what he calls "balance sheet recessions," and he considers them to be quite dangerous.
So ironically, even though this economy collapsed through no fault of its own, we are potentially in a worse position for the recovery than we were after the 2008 credit crisis because of the surge in borrowing to weather the pandemic. The two best ways of alleviating this are by repaying that debt as quickly as possible; and having the government step in with major fiscal support in the meantime to replace lost corporate investment, help speed along that process, and keep GDP from collapsing.
Long story short, all this is why I'm not surprised to hear President Trump floating the idea of a $2 trillion infrastructure package, and we'll probably be hearing plans of this size for years. Debt-to-GDP will explode here, just like it did in Japan, without being inflationary or spiking interest rates.
See you at 1 p.m...