Fed Will Eventually Break Something: But What, When and Where?

investing.com:

After years of zero interest rates, such an abrupt tightening is bound to break something.

The main questions are: what, when, and where does something break?

When rates are low credit is cheap and so financial actors tend to lever up more aggressively. Debt levels increase and so does the coverage of government debt.

Yet the reality is that governments are the issuers of fiat money and therefore they can always nominally meet their obligations by issuing more debt.

That obviously has limits too: over time they depreciate the real value of the currency and relentless fiscal deficits might lead to inflation overshoots.

But my point is that governments can kick the can down the road for a long time, but you know who can't?

You, I, and in general the private sector.

If our mortgage costs as a share of disposable income move higher we can't print money to service our debt.

If corporate borrowing costs soar and earnings growth doesn’t dramatically improve, companies will be quickly forced to deleverage or cut costs.

So in general it’s a good practice to keep an eye on both government and private sector debt levels (as the chart below shows the higher the total economic debt, the lower the rates must be to keep the system afloat).

During macro shocks countries with high and rising private debt levels are more vulnerable than countries with high public debt levels.

History shows that’s indeed the case: look at this great chart from Dario Perkins.

Japan's real estate crisis 1990s

Asian tiger's crisis late 1990s

Spain's housing crisis early 2010s

China now?

All these episodes had one thing in common: private sector debt was too high and it was rising too rapidly.

Funnily enough, the obsession with government debt levels skews the