In what was incredibly appropriate timing given the 'shocktober' market blowup, Bloomberg News invited "Black Swan" author Nassim Taleb to its set on Halloween for a discussion about the increasingly fragile market ecosystem in which we all reside, and the mounting risks that, Taleb believes, could soon ignite another financial crisis that will be even more severe than what we saw in 2008.
Taleb wasted little time in explaining how the global economy is becoming increasingly vulnerable to a global debt crisis, how the global quantitative easing did nothing to fix the underlying problem of too much debt - instead it exacerbated it - and how the inevitable reckoning might play out in markets once the long-dreaded "inflection point" finally arrives.
Taleb began the interview by describing how the global aggregate debt burden has only climbed since the crisis. And while this debt is no longer dangerously concentrated in a single sector, like, say, the housing market, it doesn't change the fact that the overall credit risk in the system has been amplified. And while central banks have for years managed to impose metastability in global markets, as they transition from a period of low interest rates back to "neutral", the destructive forces that they long suppressed will surge back to the surface.
Just like he did in the run-up to the 2008 crash, Taleb isn't trying to forecast the next crash; he's only trying to explain how the global economy has become "more fragile today" than it was in 2007.
"You put novocaine on cancer, and what happens? The patient is going to look better, he's going to feel better, but at some point, you pay a higher price."
And while this debt is distributed in different ways, "you don't get a free lunch." In other words, just because governments and corporate balance sheets have done most of the accumulating, doesn't mean that this debt is 'risk-free'.
"Governments, they think they can borrow for free. But they have had to borrow a lot. We have had to borrow more than $1 trillion dollars...and we're paying some $300 billion in interest.
This has left the US and the rest of the world on the cusp of a dangerous downward spiral.
"You can enter a spiral. In my mind, it's when governments have to borrow more and more to pay interest - like a Madoff scheme."
And once that spiral begins, it's incredibly difficult to arrest the progression.
"The minute you enter that phase, there's nothing healthy about it from an economic standpoint."
Take the US federal government for example. Not only has it accumulated another $10 trillion in debt since the crisis, but it also has "hidden liabilities" on its balance sheet that Taleb believes should be factored in to this total. Social security is one hidden liability. Student debt, which the government will almost certainly need to backstop, is another.
"But we've accumulated an additional $10 trillion in debt since the crisis. Plus we have hidden liabilities that should count as debt - like social security, you have hidden liabilities when you have to bail out firms, you have hidden liabilities from student debt...you have a lot of things, if you've committed to some expenditures, on top of debt you have hidden liabilities that should act like debt."
Circling back to central banks and their strategy for averting an all-out financial collapse, Taleb pointed out that QE's biggest accomplishment was the transfer of credit risk from individuals to the state. And with interest rates now beginning to rise, somebody is going to need to pay the price for all of this leverage.
Though debt isn't as concentrated as it once was, the first signs of stress, according to Taleb, are already beginning to surface in real-estate, where stress that has already appeared in the high end of the market will likely spread (a trend that we have anticipated again and again and again).
"The first shoe to drop will be probably real estate. The higher end real estate has already gone down world wide, people have noticed but they're not talking about it...it will be the higher end real estate first then the rest of the real estate market. One thing that quantitative easing did was increase inequality."
After real estate "the next shoe to drop" will be the stock market..."though what we're seeing today is nothing," Taleb said. Equities cannot maintain their high valuations when interest rates are rising.
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