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May
10
2022

Yes, Rates Are STILL Going Higher
Karl Denninger 

Don't be the fool.

We've spent the last nearly forty years, as you can see here, in a generally declining-rate environment.

Let me explain what this means for corporate America.

I borrow $1 million at 13% interest.  This costs me $130,000 a year to keep "outstanding."  I produce nothing for the next five years and pay the coupon with the $130,000 each year.  I've now got $350,000 in cash left (the rest I paid in interest) and I'm very bankrupt since I can't pay the million back -- right?

Wrong.

I roll it over.  I don't have to pay the million dollars.  It's five years later and the rate is 9%.  Now it costs me $90,000 to keep it out, not $130,000.  Note that I just bought myself more time, but since the market is "looser" I can borrow a second million.  This costs me $180,000 a year to keep out, but, in five more years.... I refinance it again at 5%.

Now I've only got $450,000 in cash left -- remember, I've produced nothing -- but now my "nut" annually is $100 large.  Can I get another $2 million?  Probably.  With which I sit for another five years or so and do it again, and again, and now I am eventually down to a 2% rate on the money.

I'm not out of money.  I should have been out of money seven years into this game but I got away with it for close to 40 years.  If I produce anything whatsoever with the funds I'm even better off in terms of my credit posture, and I've probably borrowed even more.  Not $4 million, probably $20 million.

My stock price, which was $5/share back then, is now $3,000 split-adjusted -- and it has split several times.

All I have to do is convince Wall Street -- or some venture hack -- that he's got something here and since the market keeps running and the cost of borrowing keeps getting cheaper they finance folks will keep letting me do it!

Here's the problem: 

None of that was ever paid back.  None of it can be, because I have no assets that are worth anything and I certainly don't have any money in the bank.  If I had assets originally they're 40 years old and likely out of date and worthless.  How much is an old open-hearth style blast furnace worth these days?  Zero.  In fact it probably has negative value because you would have to pay someone to wreck it out and haul it away, likely more than the iron and steel in the unit is worth.

But now those days, my friends, are over.

I pointed this out in Leverage back in 2011.  Oh yes, there was another burst of stupid left.  There shouldn't have been but there was and in 2020 the 10 year Treasury yield was 0.65% (!!)  You would have thought that the roughly 3% rate in and around 2011 would have been the bottom because with actual inflation running around that number you shouldn't be able to borrow for less than the inflation rate because you will pay it back (if you pay it back) with inflated dollars.

You'd have been wrong.

The difference between 3% and 0.65% is nearly a factor of five in terms of interest cost and thus the amount of leverage that can be out at 3% is less than one quarter of that which can be out at 0.65% for an equivalent coupon.

Right now the TNX stands at roughly 3.1% so that entire 4x multiple has disappeared.

The policies of our government have led to this.  The belief that we can spent six trillion dollars on alleged "pandemic relief" without consequence because rates will stay pinned to the floor was stupid.

Worse what we've done to Russia with sanctions has slammed the door on sequestering trade flows in dollars.  Why?  Because if you produce things overseas you'd be out of your mind to price them in dollars rather than your own currency when your nation might be next.  "Oh, that will never happen" sounds quaint, but how certain are you when if you're wrong you're instantly bankrupted?  Why would you take that risk when you can insist on payment in your currency?  Nobody would, nobody is and nobody will going forward.

This in turn means that every dollar spent in deficit by the federal government will instantly be reflected back into inflation.  No exceptions.

Has the Biden Administration -- and Yellen, who I remind you was running The Fed before she was running Biden's Treasury Department -- said anything about cutting that crap out?  To the contrary; they intend to continue it.

Well, good luck with that.

Note above -- a four times multiple on the amount borrowable at a given interest payment has already disappeared.

Now where was the S&P 500?

About 1350.

What is the difference between 1350 and where it is now?

About four times.

Where do you think the S&P 500 should be trading right now assuming the TNX is going to at least stay here?

Oh sure, the markets will go up and down, maybe quite a lot.  But at the core of things is the cost of financing and whether you can allegedly "build a business" that produces nothing in actual profits yet keeps getting financed and allegedly is worth more and more, and thus has a higher and higher stock price, simply because you can roll over the debt at a lower carrying cost per million every time you feel like it.

Can The Fed turn around and change its mind?

Not really, because as I've pointed out without sequestering the funds overseas via trade, which is nobody is willing to do anymore if they have an IQ larger than their shoe size, all deficit spending instantly reflects back into inflation right here in the United States and the only way to stomp on inflation is to withdraw the excess credit from the system since there's nowhere to hide it anymore.

If you think the market run over the last five or ten years has been "reasonable" you're nuts.

If you think it can be sustained with a TNX at 3.1% and flat to rising you're wrong.

And if you think The Fed is going to allow 5, 6, 8 or 10% inflation prints to continue you're wrong there too because while you might escape being bankrupted by that others will not, it eventually drives people out of the workforce as there is no point if you can't make the bills despite working and the lower half of the economic strata, from the bottom up, starves, riots, burns, loots and revolts.

Yeah.

Oh by the way did you see the recent Consumer Credit number?  January revolving (credit card) debt was +11.8%, February 16.2% and March was up more than doubled February's rate at 35.3%, all annualized.

The average American has hit the wall, is surviving on wildly-accelerating credit card balances and either the current rampaging inflation is stomped on now or we're going to get a nasty recession and probable civil unrest -- or worse.

The recession has already started -- by the data -- and is inevitable so all we're debating now is the latter and whether the government and Fed do the right thing or not the stock market isn't going to be trading anywhere near where it is today.

Mr. Denninger, recent author of the book Leverage: How Cheap Money Will Destroy the World, is the former CEO of MCSNet, a regional Chicago area networking and Internet company that operated from 1987 to 1998. MCSNet was proud to offer several "firsts" in the Internet Service space, including integral customer-specified spam filtering for all customers and the first virtual web server available to the general public. Mr. Denninger's other accomplishments include the design and construction of regional and national IP-based networks and development of electronic conferencing software reaching back to the 1980s.

He has been a full-time trader since 1998, author of The Market Ticker, a daily market commentary, and operator of TickerForum, an online trading community, both since 2007.

Mr. Denninger received the 2008 Reed Irvine Accuracy In Media Award for Grassroots Journalism for his coverage of the 2008 market meltdown.