Friends,
Spring is in full bloom up here in the mountains of Virginia. The trees have come to life, the wildflowers stand tall, and a majestic green covers the landscape.
I always reflect on how Spring represents the blossoming of new life and the celebration of youth… and I think there are parallels throughout our civilization as well.
And speaking of celebrating youth, our local homeschool co-op held its closing ceremony for this year’s first semester yesterday. All the families gathered for some light refreshments, and each homeschool class gave everyone a brief overview of what they’ve been doing for the past several months.
Then the kids had the opportunity to stand up and share their favorite moments and show off a little bit.
The drama class performed several short skits. The journalism class showed off the podcast they developed. The trades class demonstrated the wall they wired with electrical wiring, switches, and outlets. One kid – maybe 10 years old – hammered out a piano rendition for us. Another played the ukulele. And then my daughter sang a song acapella for the group. Here she is:
I’m amazed at how talented and independent-minded these kids are. And the fact that they are learning real-world skills with no emphasis placed on meaningless memorization gives me hope for their future… which will take place in an economy much different from the one we have known.
To that end, a core thesis that we’ve been building on here at The Phoenician League, and the thesis that informs much of our investment strategy, is the observation that the Age of Paper Wealth is over.
I’ve spilled tons of ink fleshing out this theme in the monthly newsletter that goes out to Phoenician League members. And I’ve attempted to explain it in some degree of detail in these e-letters as well, though it occurred to me that I haven’t done so in a while.
I know some may hear me talk about the Age of Paper Wealth ending, and they think I’m referring to paper money being phased out. But that’s not at all the case. This story is much bigger than that.
I’ll explain by starting at the beginning…
It’s 1981 and Ronald Reagan is in the White House with Paul Volcker as the Federal Reserve (the Fed) chairman. The American economy is a mess — double-digit inflation, sky-high interest rates, and a population that has spent the better part of a decade getting hammered by rising consumer prices… with an oil shortage sprinkled in for good measure.
Volcker had done the unthinkable to kill that inflation—he raised the Federal Funds Rate to nearly 20%. As a result, mortgages were going at 18% interest. Car loans were also in the high teens.
It’s 1981 and Ronald Reagan is in the White House with Paul Volcker as the Federal Reserve (the Fed) chairman. The American economy is a mess — double-digit inflation, sky-high interest rates, and a population that has spent the better part of a decade getting hammered by rising consumer prices… with an oil shortage sprinkled in for good measure.
Volcker had done the unthinkable to kill that inflation—he raised the Federal Funds Rate to nearly 20%. As a result, mortgages were going at 18% interest. Car loans were also in the high teens.
It was brutal… but Volcker’s decisiveness worked. Inflation fell back down to “normal” levels.
And then something remarkable happened. Interest rates started to fall… and they just kept falling for the next four decades.
From 20% in 1981, the 10-year Treasury yield fell to roughly 0.5% at its low in 2020. For forty years, the cost of borrowing money declined almost without interruption.
A generation of Americans came of age, built careers, bought houses, started businesses, funded retirement accounts, and then retired — all within a single unbroken era of falling rates. The Age of Paper Wealth was all they knew.
I don’t think we are aware of just how profoundly that dynamic shaped the world we live in. I’ll explain as best I can…
To my way of thinking, cheap credit is like a drug. It’s addictive. And once you fall into that addiction, it’s very hard to get out of it.
That’s because cheap credit allows you to buy things you otherwise couldn’t afford. 4,000 square-foot McMansions… a new car every few years… high-end furniture… 60-inch flatscreens on the credit card – and whatever else people spend their money on.
And that’s just on the consumer front. The impact of cheap credit on the commercial front is far worse… because it creates all sorts of distortions.
“Zombie” companies that should have gone bankrupt because they produce no economic value manage to live on by financing themselves with cheap loans. And malinvestment builds up within the system because companies undertake marginal projects financed by cheap credit in the name of “growth”.
In this environment, executives are tempted to take on leverage they shouldn’t. Boards approve buybacks instead of capital investment. Private equity loads portfolio companies with debt to juice short-term returns.
Risk gets mispriced across the board because the cost of being wrong has been artificially suppressed. The market’s natural mechanism for punishing poor allocation — rising borrowing costs — has been taken off the table.
The result is an economy that looks productive on the surface, but is quietly building up hidden fragility underneath. Plus, cheap credit causes everything to inflate in price.
Real estate prices go up because people (and businesses) can afford bigger mortgages. Stock prices go up because investors discount future earnings at lower rates. Corporate debt goes up because CFOs can borrow cheaply to buy back stock and goose earnings per share. Government deficits go up because the interest burden is manageable.
And so what you got, over forty years, was an economy that increasingly organized itself around financial activity rather than productive activity. We see this clearly in the career advice that defined this era.
Stay in school and get good grades… go to the “best” college you can and get your degree… take a high-paying job in corporate America and fund your retirement account with the 3% match.
This advice was considered so sacrosanct that the prospect of somebody dropping out of school or not going to college was considered synonymous with failure… like there was no possible way to succeed unless you followed the accepted path.
To take this a step further, this era held up doctors, lawyers, and investment bankers as the prime occupations that one should pursue if able. The kids who showed the strongest academic aptitude were pushed in those directions.
And look at the underlying implication here…
Our society subtly pushed this idea that making the most amount of money possible was the goal of education and the key to a life well-lived. It was all about chasing a high salary… not about making or building things or about developing the inner spirit.
At the same time, the factories started shutting down.
American manufacturing, which had been the backbone of the middle class since World War II, was offshored to lower-cost countries like China and Vietnam. So the Rust Belt started rusting. And communities that had built their identities around steel mills, auto plants, and furniture factories watched those plants close and never come back.
For a while, cheap credit masked the damage because home prices and stock prices kept going up. And with ever-falling interest rates, you could always refinance your mortgage and pull out your equity if you needed to. Your house was your piggy bank.
That’s what financialization does. It creates the sensation of wealth without the substance of it. It’s just not built to last… and that’s the problem.
The Age of Paper Wealth was built on a foundation — four decades of falling interest rates and cheap credit — that was never going to last forever. And in 2022, it ended.
Tomorrow, I’ll share with you the details and what I think it means for us going forward…
-Joe Withrow
P.S. Don’t forget that the first episode of the Phoenician League podcast will drop next Tuesday, April 21st, at 6:00 am Eastern. We will publish a new episode every Tuesday at the same time thereafter.
The podcast is already live with the trailer published, and it’s available on all the major platforms. This includes Apple Podcasts, Spotify, and all the others. The video version will be available on our YouTube channel as well.
Please subscribe to the podcast on whichever channel you use to get notified when a new episode is released each week. The first several episodes will lay the foundation, and then we’ll get into timely macro talk and feature some great guests afterwards.