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Credit Today: The big black hole
Published on 01/03/2009

To attract that kind of money and avoid a precipitous drop in the dollar, we had to keep interest rates far higher than they should have been during the economic downturn that preceded my election. Those high interest rates inhibited economic growth and amounted to a huge indirect tax on middle class Americans who paid more for home mortgages, car payments..."

Clinton inherited an economy that was stagnant and blighted by unemployment greater than seven per cent. Sound familiar? 

History suggests that a weakening economy and increasing deficits are not consistent with low interest rates or a strong currency. Despite Asian exporters absorbing large amounts of US and European public and private debt as compensation for trade imbalances, it is unsustainable for our spending habits to continue without a long-term rise in interest rates, inflation, or both. 

While the current economic collapse may be creating a contracting and deflationary backdrop, the long-term consequence of our consumption binge is that interest rates will rise - including the yields required to clear the government debt rollovers. Rising government yield rates will 'crowd out' private sector borrowers and create a head wind to growth as well as the indirect tax on ordinary households that Clinton describes. Those ugly issues are coming back. The difference is that the starting point is worse. US national debt is more than 300 per cent bigger than during Clinton's first term. Most European countries display similar or worsening over-indebtedness and this is before the baby boomers retire and become net consumers instead of net savers. 

The current wave of bail outs may have prevented immediate collapses and defaults but it moved a private sector indebtedness problem onto the public sector balance sheet. While the public sector balance sheet can host the indebtedness problem temporarily, the final result is deeper economic problems.

The forthcoming crowding out issues will be challenging for all capital intensive businesses. Buying receivables will be heavily affected. While inflation helps fixed rate lenders by making debts more affordable for borrowers, higher interest rates make capital more expensive. The debt buying industry has not hit bottom yet and company specific factors will cause some market participants problems. Macro economic factors may cause even more damage.

Zach Lewy, chief executive, Arrow Global

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