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The hidden meaning behind the Evergrande blow up

·Editor focused on markets and the economy
·3-min read
In this article:
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This article first appeared in the Morning Brief. Get the Morning Brief sent directly to your inbox every Monday to Friday by 6:30 a.m. ET. Subscribe

Wednesday, September 22, 2021

Debt, debt everywhere — and not a drop of it paid for

Have you heard? The United States is on the path to a showdown over the debt ceiling — again.

As the spectacle of heavily-indebted Chinese real estate giant Evergrande held investors in its sway for a second day, another drama slowly played itself out on the other side of the globe, but in a way that hasn’t yet captured the market’s attention.

As usual, the warring factions that run the government in the world’s largest economy are trying to raise the statutory borrowing limit, currently set at $28.5 trillion. As usual, Uncle Sam will resort to “extraordinary measures” to keep paying the bills until Congress and the White House strike a deal.

And, as usual, the eventual agreement won’t solve the central problem: The government simply can’t stop deficit spending, even though revenues are near the highest they’ve ever been — even in the face of COVID-19.

“Congress might go a little bit closer to the edge here,” Raymond James Ed Mills told Yahoo Finance Live on Tuesday, speaking about the debt ceiling talks.

“But ultimately, there is always a backup strategy and a backup to the backup strategy that keeps us from questioning the full faith and credit of the [U.S.] government,” he added.

However, the Evergrande crisis and Washington’s looming fight over the debt gives us an opportunity to revisit a recurring theme. For a variety of reasons — most of them having to do with rock-bottom yields and voracious central bank buying — this big macro theme has NOT been reflected in global bond markets.

Namely, economies big and small are awash in debt, with no conceivable way to pay it all down, especially as a certain virus continues its implacable march across the world.

In a less topsy-turvy world, investors would force the hands of officials by selling bonds, and driving up borrowing costs (in fact, we used to have a name for them: bond vigilantes).

The amount of debt held by the public has seen explosive growth since 2008.
The amount of debt held by the public has seen explosive growth since 2008.

Needless to say, these are far from normal times. Earlier this year, economists at Barclays issued a lengthy report that warned “ultra-low interest rates have encouraged many policymakers, economists and market participants to argue that large debts do not matter. We disagree.”

The bank added that “rates are unlikely to fall further, but global growth rates likely will. This will stress repayment capacity, particularly for low-growth high-rate [emerging market] economies.

Think of Evergrande being a microcosm of what, in a world where long-established rules of macroeconomics have not been turned on their ear, could be happening writ large in the U.S. and other major countries.

Recently, Jon Lieber at Eurasia Group recalled the 2011 debt ceiling battle that led S&P Ratings to downgrade the U.S.’s credit rating (and, as the person who led the committee making that decision said in May, the fundamentals are even worse this time around).

“Having learned these lessons, Congress smoothly extended the [debt ceiling] in 2014, 2017, 2018, and 2019 well before it became disruptive to markets,” Lieber wrote.

However, “in 2021, we may not be so lucky,” he added, explaining as Congress “walked right up to the deadline as markets started to price in inaction in the weeks before.”

All of which suggests that complacent markets could indeed get jolted by an unexpected, and very ugly, surprise if the parties don’t get their act together, and soon. And Evergrande is a reminder that, regardless of how rosy things look when the wine is flowing freely, eventually the bill will come due

By Javier E. David, editor at Yahoo Finance. Follow him at @Teflongeek

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