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From ZIRP to NIRP

How to build an $8bn company simply borrowing $1bn to start...
 
WE HAVE been in Normandy with a group of family office investors, writes Bill Bonner in his Diary of a Rogue Economist.
 
These are people who invest for a long time and tend to care less about making money than about not losing it.
 
We gave them a speech, the gist of which was that we live in a world so crazy that only a crazy person can understand it...and only a half-wit would trust it.
 
Last week the half-wits boosted US stocks. Gold rose too, uncharacteristically. Last week too, the Europeans made a mad, mad world a little madder; they moved from ZIRP to NIRP. That is, real interest rates are falling from zero to less than zero, under a NEGATIVE interest rate policy.
 
The US is still operating a ZIRP system...officially. But, unofficially, major borrowers get their money at rates that are substantially lower than consumer price inflation.
 
Take IBM, for example. Its bonds, maturing in 2017, yield 1.78%. Officially, the CPI is about 2%. But when MIT measured inflation, without using adjustments and fudges, it came up with a rate of 3.91%. This makes IBM a NIRP borrower, actually earning more than 2% on every Dollar it borrows.
 
IBM is also a big buyer of its own shares. In fact, it may be the biggest. For every Dollar it spends on genuine capital investment – in new machinery and facilities – it spends $8 buying its own shares.
 
This gives us an idea. Want to make beaucoup money? Start a company. Borrow money. Buy your own shares.
 
Everybody does that, right? But our innovation is this: Buy your own products too!
 
Follow the lead of the internet companies. Invent some social media so new and so revolutionary that nobody has ever heard of it. Raise $1 billion by selling bonds to the public. You have no credit and no credibility? No worries. The companies that have done best lately are those with the worst credit, according to Bloomberg. These "balance sheet bombs" have benefited most from ZIRP, NIRP, and collapsing spreads.
 
Everybody wants high yield. And nobody believes the Fed will allow debtors to fail. It follows then that a new company with no track record, no real product, no profits, no sales, and no business plan should have the very worst credit rating possible...and should therefore be a cinch to get plenty of credit.
 
So, say you have to borrow at twice the rate of IBM – let's say 4%. With a real inflation rate of 3.91%, you're getting money for essentially nothing.
 
But you still have to make debt payments. You borrow $1 billion. You have to pay $40 million in annual interest. But you take the $1 billion and use it to buy your products (whatever they are). Your company shows sales of $1 billion. You bring about 40% of that to the bottom line...giving you debt cover of 10 times. This makes you one of the best credit risks on the market. 
 
Then, if your shares sell for 20 times earnings (modest for a tech company), the capital value of your company will soar by 20 x $400,000,000 = $8 billion!
 
You see? You started with nothing. Through the magic of ZIRP and NIRP...along with some accounting chicanery...you now have a company worth $8 billion.
 
Sound crazy? Yes. And that is almost exactly what the Fed is trying to encourage.
 
Companies borrow. They use the money to buy their shares. Stocks go up. This "wealth effect" is supposed to trickle down to the public, who are meant to buy the corporations' products. Rising sales will produce higher profits. Stocks will go up. Everyone will be richer.
 
The risk to the short-term investor may be that he misses out on this gay insanity. Asset prices go up; he wants to be a part of it.
 
The risk to the long-term investor arrives when the economy comes to its senses.

Bill Bonner has co-authored a number of New York Times Bestsellers including Financial Reckoning Day, Empire of Debt and Mobs, Markets and Messiahs. In his own opinion, Bill's most recent title, A Modest Theory of Civilization: Win-Win or Lose, is his best work yet. Bill also founded The Agora, a worldwide community for private researchers and publishers, in 1979. Financial analysts within the group have exposed and predicted some of the world's biggest shifts since that time, starting with the fall of the Soviet Union back in the late 1980s, to the collapse of the Dot Com (2000) and then mortgage finance (2008) bubbles, and more recently the election of President Trump.

See full archive of Bill Bonner articles

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