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Wall Street used to sell convertible bonds (bonds that could be exchanged for stock at a specified price) with a twist: If the borrower couldn’t pay the bondholders, it would issue more stock. No-one wants to buy stock from a broke company, so the stock would go into a death spiral.
We called these time-bombs “death-spiral convertibles.†Credit Suisse financed Enron this way in 2001 just before the company blew up; that was one reason I left the bank early the following year.
The United States is turning into the national equivalent of a death spiral convertible, financing its ballooning trade deficit through the ballooning equity market.
America’s trade deficit nearly doubled during the Covid crisis, reaching a record annual rate of nearly $1 trillion. Depleted US manufacturing capacity can’t meet the demand for consumer electronics, medical equipment, and other goods, so the US is buying them from China.
Congested US ports can’t handle the import surge and shipping rates have spiked. Federal stimulus checks to American consumers have turned into a bonanza for Chinese and other foreign factories.
How is America paying for its imports? By selling stocks to foreigners, according to Treasury data. Foreign investors have been dumping low-yielding US Treasuries and corporate bonds during the past year, according to the Treasury International Capital (TIC) system.
Foreign investors bought $400 billion of US equities and nearly $500 billion of US agency securities (backed by home mortgages) during the twelve months through January, but sold $600 billion of Treasuries and $100 billion of corporate bonds.
Get it? The Federal Reserve buys $4 trillion of Treasury securities and pushes the after-inflation yield below zero. That pushes investors into stocks. Foreigners don’t want US Treasuries at negative real yields, but they pile into a stock market that keeps rising, because the Fed is pushing down bond yields, and so forth.
At some point foreigners will have a bellyful of overpriced US stocks, and will stop buying them. When this happens, the Treasury will have to sell more bonds to foreigners, but that means allowing interest rates to rise, because foreigners won’t buy US bonds at extremely low yields.
Rising bond yields will push stock prices down farther, which means that foreigners will sell more stocks, and the Treasury will have to sell more bonds to foreigners, and so forth.
That’s a death spiral. It’s not inevitable, but it’s a serious risk.
Be afraid. Be very afraid.
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