Drunk on Debt

The world’s biggest beer maker just secured the king of debt deals. Looks like the high life is just about over.
From the March 2016 Trumpet Print Edition

The makers of Budweiser beer just set a record. In November, Anheuser-Busch InBev secured a $75 billion loan to buy rival sabMiller. It is the biggest corporate loan in the history of the world. And it may signal a dangerous event for the global economy.

Last year, for the first time ever, global mergers and acquisitions surpassed the $5 trillion mark. It was the third consecutive year of increases—up a whopping 37 percent from 2014, according to Dealogic. The number of deals valued at $10 billion or more was double the 2014 level. The number of global jumbo bonds financing these deals also hit a record last year—up 48 percent from 2014.

Corporate America led the charge. Egged on by artificially appealing low interest rates and crowds of investors clamoring for yield, American companies made up the highest share of global mergers and acquisitions ever.

But for those still with unimpaired vision, these signs are very worrisome. We had a corporate merger spree not that long ago—two of them actually. They both ended the same way, too—and it wasn’t with clanking beer mugs and cheers.

Precedent

In 2006, at&t bought BellSouth for $84 billion in stock. In 2007, the Royal Bank of Scotland (rbs) and other foreign banks purchased abn amro Holding for $100 billion. Just a few months later, shareholders took over Philip Morris International for $107 billion. At the time, these were three of the top seven corporate buyouts in history.

Only seven months later, investment bank Bear Stearns collapsed, setting off a panic that left Wall Street a total mess.

The same corporate excesses preceded the dot-com crash too. Of the 15 biggest corporate mergers and acquisitions of all time, eight came within two years before the crash in 2000. The second-biggest deal ever—the $185 billion Vodafone acquisition of Mannesmann—came just four months before the crash. The biggest deal ever, the $186 billion aol-Time Warner merger, happened less than three months before markets tumbled.

These corporate moguls were partying right up to the day the market tanked.

The Debt Party Continues

“Anheuser-Busch InBev’s ability to raise $75 billion in the loan markets in the space of a few weeks shows that banks are still willing to support top-class borrowers in record amounts,” Nicholas Clark, a partner at Allen & Overy’s international law firm in London, said. “This is the largest commercial loan in the history of the global loan markets, far surpassing pre-crisis values” (emphasis added throughout). It is part of a $108 billion deal. At a dollar per bottle of beer, that is more than 14 bottles for every person on Earth.

So the debt party continues. But what happens if the debt kegs run dry?

Investors are already feeling jittery. Last August, market volatility shot up so high that for a brief period, it blew out the Chicago Board Options Exchange Volatility Index. This is the index often referred to as the fear gauge. The computer algorithms couldn’t handle the unprecedented volume as the index tripled.

Somebody is going to be cut off—probably a lot of people. And Wall Street is just now beginning to realize it.

‘A Wealth Effect’

Stanley Druckenmiller, one of the most successful investors of all time, said this last April: “This is the first time in 102 years A) [that] the central bank bought bonds, and B) that we’ve had zero interest rates, and we’ve had them for five or six years. … To me it’s incredible.”

Never before has America’s central bank so overtly manipulated markets. Never before has America printed up so much money from nothing. Never before have interest rates been artificially suppressed so low and for so long.

Never have markets so hinged on the whims of central planners.

But the drinks can’t keep coming. Former Federal Reserve Bank of Dallas Chairman Richard Fisher warned on January 5 that this liquidity might soon be in short supply. He told cnbc, “What the Fed did, and I was part of that group, is we front-loaded a tremendous market rally … in order to accomplish a wealth effect.”

This was an incredibly revealing statement. It confirmed that quantitative easing—money printing and interest rate manipulation—was directly responsible for boosting prices of risk assets like stocks and bonds.

In other words, the economic rebound from the 2008 financial collapse was not due to any fundamental improvement in the economy—but to artificial, temporary stimulation. It was due to debt!

After 30 years of generally falling interest rates, and seven consecutive years of zero-bound interest rates, the whole economy is dependent on a combination of two untenable factors: artificially low interest rates, and continually expanding debt loads.

Debt Dependency Can’t Last

On December 16, the Federal Reserve was finally forced to raise interest rates. It was only by a quarter of a percent—but it is the direction that is important. Interest rates are rising again. Debt—the alcohol fueling corporate America’s animal spirits—is becoming more expensive.

And look what happened to the markets. The Dow Jones Industrial Average, which tracks America’s most important companies, fell 8 percent in a single month. The S&P 500 is down. The nasdaq is down. Oil is down. Virtually all commodities are down. Virtually every currency in the world except the dollar is down.

Granted, there are other issues at play. But the fact that the world’s largest economy is so dependent on debt—and that debt is becoming more expensive—is a huge factor driving markets down.

Investors should be afraid.

“In a crowded hall, exit doors are small,” the rbs warned in a note to clients in January. Investors need to brace for a “cataclysmic year,” it said. Market indicators are flashing warnings akin to months prior to the Lehman crisis in 2008.

The bank warned that if the debt kegs run dry, it will lead to a global deflationary crisis. Major stock markets could fall by a fifth, and oil may plummet to $16 a barrel. The bank recommends that clients look to the dollar for safety.

But will the dollar really protect people?

“We are already in or rapidly heading into a recession,” says Euro Pacific Capital’s Peter Schiff. “Corporate earnings are already falling. Stocks are way overvalued, and companies are way over-leveraged.”

“I do think the Fed is going to save the market,” says Schiff, who was one of the few analysts who correctly saw the 2008 crisis coming, “but sacrifice the dollar in the process.”

What If the Dollar Tanks?

If the markets tumble, the Fed will print money and flood the market with debt, says Schiff. And what was a deflationary crisis will quickly turn into an inflationary one in which the value of the dollar is destroyed.

“So the real crisis that is coming is not going to be a repeat of the financial crisis,” says Schiff, “but something even worse—a dollar crisis and even a sovereign debt crisis.”

This next economic collapse is going to be much harder on Americans because debt levels are so much higher. Anheuser-Busch InBev/sabMiller may do fine for a while since consumers tend to embrace vices and the small pleasures in hard times.

But the writing is on the beer billboard for all to see.

U.S. nonfinancial corporate debt hit $5.4 trillion at the end of 2015. That’s up 59 percent from the start of the 2008 economic crash. But don’t worry about debt; just like Guinness, it’s “The Most Natural Thing in the World.” Labatt confirms: Good Things Brewing. Relax a Little; Rolling Rock Is Still Free Flowing. Enjoy a Pabst—It’s Blended, It’s Splendid. Have a Bud Light and Hit Your Refresh Button.
It Doesn’t Get Any Better Than This! Turn It Loose! It’s Brewed With Pure Rocky Mountain Spring Water.

But catchy slogans don’t change reality: The high life is just about over. Real life beckons. The next crisis is coming.

Signs of Excess

America’s rich are partying like it’s 1999 … or 2006. In January, a Hermès Birkin bag sold for $99,750. This past summer, a similarly styled cultural symbol of status—also known as a purse—sold for $221,844. Manhattan condo prices hit a new record, with the median prices surging 21 percent, surpassing pre-Lehman highs. You can even buy a $100 edible 24-karat gold-covered donut dunked in Cristal-infused icing in Williamsburg, Brooklyn. Or you can pay $1,000 per dozen.

In 2014 (the latest data available), CEO compensation rose sharply. Total compensation at Standard & Poor’s 500 companies jumped by 10.6 percent. The median income for a CEO of an S&P 500 company was $11,291,000 in 2014, while the Russell 3000 counterpart earned $3,885,000. Health-care CEOs led the way, jumping 73.6 percent between 2010 and 2014.

Add to that the Picasso painting that sold for a record-breaking $179 million in May, the Blue Moon diamond that sold for a record $48.5 million in November, and the fact that 2015 saw more rare U.S. coins reach $1 million at auction than ever—and this perhaps explains why 2015 can be described as a year of American excess.