Debt is Fueling the Global Economy

By now, you’re well aware that the Fed did not raise interest rates on Thursday.

There was no real consensus on what the Fed would do from the economist/strategist-types. From what I could tell, it was about 50/50 whether the Fed would hike.

The pro-rate hike camp’s argument was basically that the U.S. is no longer in an emergency situation, and so interest rates should not remain at emergency levels.

Makes sense. The unemployment rate is hovering just above 5%. And yeah, that 5% doesn’t count a couple million people who have dropped out of the workforce. The fact that wages haven’t risen in over 10 years is an issue, too.

But still, 5% is pretty darn good. And it seems to me a couple quarter-point rate hikes won’t have much of an impact on bringing people back to the workforce or paying them more, anyway. 

Those against rate hikes are looking at inflation numbers and the global economy. The official measure of inflation isn’t measuring very much right now. Inflation continues to run at a sub-2% annual rate. The conclusion is zero interest rates have not sparked inflation, and so there is little risk in leaving them at zero.

Plus, the global economy is very weak right now, in large part because of China’s slowing economy. I’ve discussed at length in past Wealth Daily articles how China’s economy presents the word with a double-whammy. On the one hand, as its economy slows, it buys less fewer materials like iron ore, copper, etc., so commodity prices have been plunging, putting a real strain on commodity-based emerging market economies.

And on the other hand, much of China’s growth over the last 15 years came from building factories that churn out electronics, clothes, steel, cement, and so forth. China built so much that the world has too much stuff. We can’t use it all. So not only is China screwing over the emerging market economies, but it’s screwing itself over, too.

Thanks, China!

The thing is, China is heavily indebted. You’ll notice that anytime the world gets really concerned about China’s growth problems, China resorts to come kind of stimulus — lowering interest rates, lowering reserve requirements for banks to make loans, devaluing its currency. Earlier this year, China even forgave a bunch of loans to local governments.

The reason for stimulus is to encourage people and companies to take on more debt. Period. Obviously, when you take on debt, you’re spending on something. Money is continuing to move around the system.

But it’s not real money, as in money that has been earned or saved. It is future money that will be earned or saved in the future. This is why they say debt steals future income: because you’re taking money that you will make and spending it now. The money you eventually make will simply pay back what you already spent. 

Now, it should be clear that debt in and of itself is not a bad thing. Not many people can simply save up $150k and buy a house. Loans make homeownership a lot easier. 

And if inflation works as it should, your ability to pay back a loan should improve over time as values and wages rise. Of course, that’s not happening. And it’s largely China’s fault. 

In many ways, the American worker now competes directly with the Chinese worker. All those iPhones we love so much get built in China and shipped here by the boatload for a savings of maybe $10 per phone.

But the irony is that 10 bucks doesn’t help Chinese workers or American workers. Chinese workers’ wages have now risen to the point that it’s far less economical for many companies to send manufacturing there. And American workers’ wages have stagnated to the point that it’s much harder to make ends meet. 

And that $10 in savings just sits in Apple’s ridiculously huge bank account.

Can Interest Rates Help?

The world is fueled by debt right now. It’s a bad situation because we simply don’t know how long it can continue. But one thing seems clear: The Fed is terrified to make debt more expensive and throw a monkey wrench in an already creaky machine. 

If you ask me, that’s why the Dow sold off nearly 300 points after the Fed’s decision to keep rates at emergency levels. 

I suppose we could say that it would be irresponsible to make a move that would impose more problems on the global economy. That could potentially create a no-win situation out of a situation that’s already pretty bleak for much of the world.

Now that I’ve painted the bleak picture, I have to say that the U.S. economy is better positioned to get through this than any other economy in the world. There’s still no better place to start and grow a business than here. And that means you can still find great businesses to invest in.

My advice to my Wealth Advisory readers is the same as it has been for a while: Buy companies that pay dividends and focus on the U.S. economy. Think consumer discretionary and tech stocks, with a little bit of domestic financials thrown in. 

I still really like Bank of America (NYSE: BAC). At some point, we will get some interest rate hikes. A 100 basis-point move will add $2.2 billion in profit to the bank.

And J.C. Penney (NYSE: JCP) is an excellent consumer discretionary turnaround story. There’s a new management team in place that looks very competent.

As for interest rates, the Fed says it still wants to raise this year. We’ll see. At this point, I think it looks pretty unlikely. Whether the market sees that as a good thing or a bad thing remains to be seen.

Until next time,

Until next time,

Briton Ryle

@BritonRyle on Twitter

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.