Saturday, February 7, 2015

Ten Times Worse Than RadioShack

Updated 8 February, 2015

David Stockman has written a very thorough piece on the condition of the economy – specifically the amount of debt and the impact that the debt has on inflating many things, including asset prices and favored economic indicators, specifically GDP.

I would like to focus on one aspect of his commentary – and it starts right at the top:

Bloomberg News finally did something useful this morning by publishing some startling graphs from McKinsey’s latest update on the worldwide debt tsunami. If you don’t mind a tad of rounding, the planetary debt total now stands at $200 trillion compared to world GDP of just $70 trillion.

The implied 2.9X global leverage ratio is daunting in itself.

Keep that ratio, 2.9X, in mind.

In most cases, when people speak of debt leverage ratios, they are considering debt relative to earnings or cash flow, or debt relative to assets or equity.

Comparing debt to GDP would be similar – to the extent GDP means anything (which Stockman does an excellent job later in the post of demonstrating it means little) – to comparing debt to the revenue of a company.

This is where RadioShack comes in:

RadioShack Corp. filed for Chapter 11 bankruptcy protection in the face of mounting losses, according to media reports late Thursday.

The company filed bankruptcy.

What was the RadioShack debt to revenue ratio before this cataclysmic event?  For 2013, the revenue was $3.4 billion; the debt was $614 million.  This makes the ratio 0.2X.  The debt grew significantly in 2014 – by over $200 million – pushing the ratio to somewhere around 0.3X.

Remember, the global balance sheet is levered ten times as much, at 2.9X. 

Not a fair comparison, you say?  RadioShack was a sickly company, not healthy and vibrant like the global economy?  (Don’t write to me about the “healthy and vibrant” comment; just work with me.)  It could never carry the debt load that a healthy, cash-flow-positive company could carry, you exclaim!

OK, I’ll bite.

What about 3M?  About 0.2X.

Caterpillar?  0.7X.

Exxon Mobil?  0.06X.

How about JPMorgan?  11.0X!!!!!

So many statements can be made from this simple analysis, probably none of them terribly earth-shattering.  First, globally debt is high – at a ratio 10 times as high as the now-bankrupt RadioShack.  Second, the leverage is in the banks – no big surprise, I know.  But what is the purpose of banks other than to fund productive assets?  Why should banks be so highly leveraged?

We know in today’s Ponzi-financed world that banks are not limited to funding productive assets.  With unlimited access to and free supply of cost-of-goods-sold and a backstop of government and central bank largesse, why would banks self-limit their leverage?  Of course, they don’t.

What about so-called national, or sovereign, debt ratios?  It is easy to find the ratio of government debt to GDP, but – despite the many efforts to make it so – not all GDP is available to the government to service the debt.  What about debt as a ratio to revenue – meaning tax and other receipts?

Putting together data from a couple of sources – government debt as of 2012, and government revenues of various years (2011-2014) – for countries with more than $1 trillion in outstanding debt I come up with the following ratios for debt to tax revenues:

United States - 5.9X
Japan - 5.7X
China - 1.8X
Germany - 1.7X
Italy - 2.3X
France - 1.5X
United Kingdom - 1.4X
Brazil - 1.4X
Spain - 2.3X
Canada - 1.8X

All somewhere from 5X to 20X worse than RadioShack, with the two worst offenders being the two countries whose currencies have, in the last several decades, been in most demand globally.

Back to global debt: productive assets carry a debt-to-revenue ratio of well below 1.0X, more like 0.2X.  Globally the debt ratio is 2.9X GDP – with banks and sovereigns well above this international average.  Banks and sovereigns: the two hands that wash each other, creating credit with seeming immunity to failure – thereby securing commodities at a rate far higher than a properly functioning market would allow.

There are a lot of unproductive assets being supported by the global Ponzi.  A peek into the fate of RadioShack will give us some idea of the fate of this hypothetical global company:

Shares of the 94-year-old consumer electronics chain were delisted by the New York Stock Exchange earlier in the week.

Delisted.  What might that look like on a global scale?  This is precisely what the central-bankers have been working so hard to hide from us, especially since 2007.  

The asset-price bubble will burst – when, I don’t know.  Many assets will be worth exactly zero, or less than zero as the cost to dispose of many assets will be higher than the disposal value.  Rotting buildings, rotting equipment, rotting cities and towns – left to die in place.

But not all assets.  There will remain many productive assets; the holders of these – while they might be nominally worse off (due to the re-pricing of assets) – will at least own things of value, with the ability to generate income.

Those holding the debt of those entities too highly levered (whether banks, sovereigns, or otherwise) will be left holding the bag – an empty bag.

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