危险的三重奏

Amid the world’s many troubles is the growing possibility of a combination of the bursting of a bubble, a major government and corporate debt crisis and the possibility that a popular investment strategy — lifecycle investing or borrowing to invest — will all implode at the same time. Once upon a time, conservatives were quick to argue that we’ll all be rooned if governments take on too much debt.

While true in extreme cases, it was more of a device to deny any political party’s calls for welfare spending and, indeed, any spending on social good. Moreover, the mantra was that tax cuts would pay for themselves. Recently _The Economist_ (18/10) published a special report on the world economy. The author, Henry Curr, argued that historically debt crises have mostly been a poor-world problem.

“Yet today the biggest, richest countries have fallen into as dangerous pattern of borrowing ever more. Debts have reached vertiginous heights and bond markets are showing resistance,” he writes. Curr says gross public debt as a share of GDP in advanced economies stands near 110% – close to an all-time high at a time when inflation is increasing in many countries.

He uses an example of possible outcomes in a July speech by Gregory Mankiw of Harvard University about what needs to happen to bring to an end America’s unsustainable accumulation of debt. He argued that there are four options: big cuts in government spending; extraordinary economic growth; large tax increases; or large-scale money creation – otherwise known as inflation.

In this context, Curr argues that cuts in spending are unlikely given ageing populations and their political power; economic growth wouldn’t solve the problem; the unlikely AI boom would continue; and high-skilled immigration would not be feasible. That leaves tax rises, default on debts, inflation or some combination of them all.

Curr concludes: “In the absence of bold action by governments, more inflation is coming. When it does, it will be politically toxic for rich democracies already grappling with a surge in authoritarian populism. Buyers of long-term bonds today will be unhappy and the wider world will be worse off for it.

” Jessica Riedl, a senior Manhattan Institute fellow, writing in The Washinton Post, said America’s debts trends are simply unsustainable. Britain is in a fiscal mess and engaged in a borrowing spree which has pushed interest costs to almost 10% of public spending – 50% higher than the defence budget.

France’s fiscal chaos is causing government collapses and Greece and Italy are exceeding France’s debt. Needless to say this situation, bad as it is, is better than that of the US. While all this is going on, the risk of an AI bubble bursting, with its impact on markets and the broader economy, is growing.

Jeffery A. Sonnenfeld and Stephen Henriques, have written for _Yale Insights_ (28/10) that there are three ways the AI bubble could pop. First, is the risk that concentration leads to contagion. A small group of companies are securing most of the major deals. “Should the bold promises of AI fall short, the dependence among these major AI players could trigger a devastating chain reaction, causing a widespread collapse similar to the 2008 Global Financial Crisis."

Second, governance conflicts could expose AI shortcomings. They cite the career of Sam Bankman-Fried where poor governance and limited regulatory oversight led to the disastrous cryptocurrency problems of that time. Now those Trump supporters who have invested in the various Trump crypto plays might find they end up facing massive losses – particularly given that many of them have no investment experience and are investing simply because Trump encouraged them to.

The third problem they cite is a new version of the fibre-optic cable infrastructure overbuilding during the 1990s dotcom bubble when financial engineering was the focus rather than effective infrastructure. The authors cite the famous words of Charles Mackay, author of the business classic Extraordinary Popular Delusions and the Madness of Crowds, which looked at the psychology of crowd behaviour and mass hysteria throughout history from the Dutch Tulip Mania of the 1630s onwards.

“Men, it has been well said, think in herds; it will be seen that they go made in herds, while they only recover their senses, slowly, one by one.” The third leg of a possible major crash is the growth of “lifestyle investing”. It had been almost axiomatic after a book by Ian Ayres and Bary Nalebuff that investors should take on more risk when young and look for safer investments when older.

It was influential but a new factor has emerged – borrowing for that first stage. The Economist (29/9) points out that the strategy has been effectively turbo-charged due to the proliferation of ways in which retail investors can buy stocks. They cite one investor whose portfolio loan to value ratio is between 50% and 65%.

History tells us that such situations are likely to be catastrophic in any market turndown. Indeed, in today’s investment industry, a leveraged portfolio drop in value could trigger automatic sales of any holdings. What’s the likelihood of all this happening? Who knows? We do know that contagion in one area of the market can have spill-on effects.

We also know that, despite all the protestations about debt being bad, governments around the world are going deeper and deeper into it, reducing their capacity to respond effectively to the next financial crisis. Companies, individuals and families are also incurring greater debt, ….and who would be confident that the current leaders of our bigger states would be capable of dealing with the event if the trifecta of potential financial problems came to pass?

But it is a safe bet that at the first whiff of trouble, Trump will be dumping his crypto investments and leaving the investors he has encouraged to buy holding the bag. The views expressed in this article may or may not reflect those of Pearls and Irritations.