Photo: Richard Drew

Has the era of cheap credit finally come to an end?

  • December 16, 2015

Capitalism & Crisis

The interest rate hike by the US Federal Reserve could trigger a new credit crisis extending from US corporate bond markets to emerging economies.

This article was originally written for teleSUR English.

Wednesday’s decision by the US Federal Reserve to raise interest rates for the first time in nearly a decade is likely to send shock waves through financial markets.

Over the past decade and a half, and in the last six years in particular, the world economy has been weaned on — and become addicted to — cheap credit. Ever since the deflation of the dotcom bubble in 2001, and especially after the financial crash of 2008, the Fed has kept its interest rates at historical lows.

In the mid-2000s, this cheap credit policy, made possible in large part by Chinese purchases of US Treasury Bills, made it extremely easy for investors to borrow money, leading to a wave of speculation on subprime mortgages — a boom that eventually turned to bust, causing a ripple effect of financial sector bankruptcies that nearly brought the capitalist world economy to its knees.

Financial authorities in the US and around the world responded to this crisis by lowering interest rates even further and pumping trillions of dollars into the global financial system. While this prevented wholesale collapse in the short-term, the nature of the response only fed investors’ addiction to cheap credit, blowing up a series of new bubbles in the process.

Today, the Fed is finally showing signs that it wants to “normalize” monetary policy by raising interest rates. Officials seem to believe that the crisis is now over, pointing to the resumption of growth and the stabilization of credit markets as evidence for a recovery.

The problem is that this supposed recovery always rested on a bedrock of speculative investment — all of it made possible by the same cheap credit that caused the crisis to begin with. In the last six years, the Fed and other major central banks basically papered over deep-seated structural problems in the world economy by showering investors with free money in the hope that some of it would trickle down into the “real” economy.

Of course this “trickle-down” effect never materialized. Fresh data from the Pew Research Center shows that one in five US adults now live in or near poverty, with 5.7 million people having joined this category since 2008.

In response to the data, the Financial Times noted that “many of the new poor, or near-poor, have become so even amid an economic recovery that [has now led] the US Federal Reserve to raise interest rates … [A]lmost 2.5 million adults have joined the lowest income ranks since 2011, long after the post-crisis recession was ostensibly over.”

In contrast to working people, the junkies in the financial sector thrived during this period — but, as always, the high will only last so long as their dealer remains willing (and able) to maintain its supply of cheap credit.

Wednesday’s interest rate hike therefore poses a host of problems for investors, who may now be forced to go cold-turkey on their lucrative carry trades, in which they borrowed cheaply from the Fed to speculate dearly in high-risk bond markets.

In fact, the warning signs are already on the wall. Corporate bond markets, junk bond markets and emerging bond markets all experienced intensifying financial stress and became increasingly jittery ahead of the expected Fed announcement.

To take just one of the most egregious indicators: the total value of corporate bond defaults has shot up to $95 billion this year, the highest level since the global financial crisis, as corporate borrowers — led by US oil and gas companies — struggle to pay back the loans they took on when credit was still cheap and commodity prices high.

The trouble has been especially pronounced in the so-called “high yield” or “junk bond” markets, centered on the most risky corporate investments. Signs of financial stress in junk bond markets were compounded last week when major investment firm Third Avenue announced the suspension of its $800 million Focused Credit Fund, marking the largest failure of a US mutual fund since the financial crisis of 2008-’09.

The announcement sent jitters through financial markets, especially in light of the Fed’s widely expected interest rate hike, which will now inevitably increase corporate default rates and is likely to lead to further mutual fund and hedge fund failures in the months ahead.

Corporate bond markets are not the only ones under stress: emerging markets are feeling the heat as well, as investors increasingly withdraw money from once-fast-growing developing countries like Brazil, Turkey and South Africa. China, meanwhile, the world’s second biggest economy, is struggling with serious financial troubles of its own.

Whether all of this will lead to another major financial crisis in the short term remains to be seen. The Fed will probably increase rates very slowly over the next year, in attempt to prevent fresh panic. Still, as the era of cheap credit inexorably draws to a close, an important question arises: will US officials still be able to keep Wall Street’s hopelessly addicted junkies under control when the withdrawal symptoms kick in?

If the answer to that question is no, which looks increasingly likely, we may be in for tumultuous times.

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