Corporate Debt, Crypto and the Looming Catastrophe
By Patrick Tan on ALTCOIN MAGAZINE
The thing that sometimes keeps people (myself included) up at night is the looming debt burden of a house, a car or such other big ticket item for which a use of credit is more in line with civility than an outright payment in cash. But one of the things I learned pretty early on in my career as an insolvency lawyer was that when you owe the bank a sum of money, they own you, but when you owe the bank enough money that your inability to pay them would destroy them, you essentially own the bank. As in life, small is seldom beautiful in the banking world. Which is what makes the next looming financial crisis all the more worrisome.
Unlike the Great Financial Crisis of 2008 (not sure what was so great about it, but I digress), the next credit-fueled crisis is hidden in plain sight, amidst the tomes of countless annual reports of listed companies and other corporate vehicles, which, taking advantage of historically low interest rates, engorged themselves on debt, which has the potential to plunge the world into another financial crisis.
As recently as July this year, CNBC reported that while global debt hit a new record at US$247 trillion, that’s trillion with a “t,” the non-financial sector (meaning corporate paper) accounted for US$186 trillion of that debt, or over half of all debt today is corporate.
“Who cares?” I hear you say or “How does this affect me?”
After all, how does corporate debt affect me as a consumer? In ways you may not expect. The problem with corporate debt is not so much that companies are borrowing (companies have always borrowed), but what they are doing with that borrowed money that makes it all the more scary. Firms have used artificially cheap money to buy back stock in the equity markets — the most unproductive use of (highly leveraged) capital in terms of economic output. It would be one thing to say, borrow money to invest in research and development or to build bigger factories. Even if the money was being borrowed to finance higher salaries, technically those higher salaries should translate to increased consumption, driving higher economic activity which could fund growth in company revenues. Instead, the promise of cheap money and an easy buck are driving executives to line their pockets through share buybacks. And considering that a huge chunk of corporate compensation at the very highest echelons these days are in stock, executives have every incentive to use their companies to borrow money for stock buybacks to goose their own personal returns.
Another favorite play is to use leverage to acquire companies and eye-watering PE multiples. If you consider a 100 times price to earnings ratio a fair value — just remember that that means you expect the company to increase its earnings by 100 times based on the current price of its share. But when companies use leverage to buy other companies, accounting magic allows them to book investment gains on the acquired entity, stoking shareholder returns which ultimately rewards boards and shareholders far in excess of any benefit to the company as a going concern.
But ultimately, someone is paying for top executives to line their pockets and as you would have guessed it — it’s the people at the very bottom of the food chain — the employees.
Here’s how it works. If executives use the company to borrow money for stock buybacks, the company’s debt level increases, making it more challenging to borrow money for other essential economic activities such as trade finance and working capital. This means that there’s also a disincentive to increase wages and to spend on R&D, things which are essential to increase consumer spending and to grow company revenues. With quarterly reporting, CEOs are pressured to turn in good numbers at earnings calls, which encourages a dangerous short term-ism by the very corporate leaders who need to take long term views in the interests of the company as a whole.
All this creates a dangerous setting for the next major financial crisis — only this time it won’t be led by banks and financial institutions, but by companies, straining under their enormous debt burdens. And considering that much of that debt was not used to fuel economically productive activities, when the chickens come home to roost, companies, which had kicked their debt buckets down the road will be in for a Category 5 storm of unprecedented proportions.
So what has all that to do with crypto?
If you recall the initial coin offering (ICO) craze of late 2017 and early this year, you’ll remember that with ICOs, the promise was of future product or services with the purchase of a digital token. The presumption (or story) was that as these companies developed desirable goods and services, their token value would go up as more customers deigned to use them.
Many ICOs were scams, but many also used the monies raised through the ICO process to begin building products and rolling out services and as working capital — but more importantly, these companies didn’t use ICOs as leverage — an important distinction with the debt-fueled binge in corporate debt, which has been funneled into unproductive uses such as share buybacks.
Even if an ICO fails (which many are wont to do), losses to purchasers of an ICO’s digital tokens are only left with useless and potentially valueless digital tokens and I need to stress this, IN THE EVENT that the ICO was never making anything valuable to begin with. Let’s not forget for one minute that the raison d’être of a digital token issuance, no matter how ostensible, was for something of utility. But in the case of a massive company, which has taken on huge debt burdens to fund share buybacks and costly overvalued acquisitions, a small increase in interest rates or an external market shock may be sufficient to push a company over the edge — a liquidity event which under normal market conditions (though I don’t really know what counts for normal anymore) should not result in any crisis, may have a domino effect and roil financial markets once again — only this time and unlike in the Great Financial Crisis of 2008, the malaise will be more severe. How? Well in 2008, banks and mortgagors were the once mostly affected. When the market for corporate paper dried up, it sent globalized economies into a tailspin, but the bailouts from the government helped to stave off a prolonged economic depression. Things will be different in the next crisis. You can’t (maybe you can) technically pay someone to take money from you and with interest rates close to zero, negative interest rates to do so to attempt to re-inflate asset bubbles once again may not work. What makes the looming corporate paper crisis even more alarming is that these are companies which directly provide employment, whereas in 2008, it was banks which were affected — which indirectly affected companies — this time, any crisis will hit much closer to home. The chickens will finally have come home to roost.
In such a scenario, imagine where the market for corporate paper dries up — who knows which will be the last shoe to fall? Companies which desperately rely on corporate paper to fund working capital will suddenly find that the credit markets have frozen up, making it difficult to fund salaries and day-to-day operations. In such a situation, ironically, it’ll be the ICOs which may survive.
And while this opinion is highly speculative, the next crisis may very well be the one to reorganize the global economy to a tokenized one, because otherwise, where is the next round of salvation going to come from? Let’s think things through logically. First, the current globalized economy has heavily favored the 1% — tokenized economy or not, that’s not likely to change within the foreseeable future. Rich people will be rich, there were even rich communists, so let’s not kid ourselves. The introduction of the ICO became an opportunity for a reallocation of resources — for some plucky investors who weren’t the sort that appear on the back pages of the Tattler to gain inside access to the avenues of the rich and connected. Second, there may be a limit to how much more goosing of returns can be done at the very top end, with a need to rely on the power of the masses to fund economic activity. Now hear me out. One of the very advantages of cryptocurrency is its ability to be denominated in extremely small units. Bitcoin for instance is divisible to 100 million parts, the smallest of which is affectionately called a Satoshi. But even Bitcoin itself is scarcely egalitarian and it’s widely known that almost 80% of Bitcoins are concentrated in the top few addresses. But tat doesn’t mean that the advantages inherent in cryptocurrencies are made redundant. Let’s not forget that Bitcoin started off as a movement, it was supposed to begin the conversation, not end it. And now that the cryptocurrency genie is well and truly out of the bottle, there’s no stuffing him (or her) back in. In other words, after the next crisis (I’m assuming there’s going to be one because we are human after all and have difficulty in learning from past mistakes), we’re going to need to tap into the economic energy of a hitherto untapped capital resource — everyone else. That’s everyone who’s been excluded from the global economy. I’m talking about the unbanked, those who have poor credit ratings, or those without credit ratings, those without access to investment opportunities in the capital markets — cryptocurrencies have the potential to upend a cycle of exclusion which the majority of people across the world have had to suffer the indignation from for millennia. Communism didn’t work, socialism is still a maybe and capitalism is the worst form of economic governance except for all the others. Perhaps the cryptocurrency revolution is what we need to create a more just world, where more of its members have a hand in both the building as well as the spoils of the economic resources of the world.
Perhaps this next crisis may be precisely what the world needs.
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The purpose of ALTCOIN MAGAZINE is to educate the world on crypto and to bring it to the hands and the minds of the masses. This article was written and composed by Patrick Tan on ALTCOIN MAGAZINE.
