Globalnomics

Wil VanLoh and Kyle Bass, college buddies while at Texas Christian University studying finance, reminisce about being so poor they had to hang their heads out of the window to avoid exhaust fumes when riding in Wil’s clunker with the heater on during winter. Since then, each has made his mark in finance.

Those familiar with the upstream energy sector recognize VanLoh as the co-founder, president and chief executive of Quantum Energy Partners, an energy-focused private-equity shop with $6.5 billion under management and some knowledge of delivering a return on investment.

Bass, principal of Hayman Capital Management, an asset-management company and investment manager of two hedge funds with more than $740 million under management, rose to prominence when he rightly predicted the collapse of the sub-prime mortgage market and betted heavily on it.

It may come as a surprise that the two financial architects are predicting a global economic crisis. They shared their perspectives at the recent Executive Oil Conference in Midland.

After predicting the housing bust and subsequent economic fallout, Bass dug deeper and discovered tainted sub-prime mortgages were just symptoms of a global economic cancer. That cancer is born of a massive debt binge by nations, corporations and individuals and has been promulgated by lower and lower interest rates over the past 30 years. In the past decade, the world has added $100 trillion in debt, growing 11% annually, while world gross domestic product has grown just 4%.

“That’s $100 trillion of money that the world spent that it didn’t have,” said Van-Loh. “Is the growth the world experienced over the past decade real, or an illusion?”

Global debt-to-GDP skyrocketed to 350% currently, the highest in history. As debt piled up, interest rates had to drop sharply to sustain the debt-financed consumption. Lower rates forced money managers worldwide to seek higher-risk returns, leading to bubbles in the housing, stock and commodities markets. World currencies have depreciated 80% measured against gold.

But now, interest rates are nearly zero. Any upward movement pressures world governments’ ability to pay. “The debt-driven prosperity train has ground to a halt as the marginal unit of GDP created from each dollar of debt has reached its end game. Deleveraging—returning debt to normalized levels—is unavoidable and will be painful,” VanLoh said.

Measuring debt against GDP ratios, Bass foresees a steady stream of government defaults, particularly in Europe. The reason: governments have essentially moved private-sector debt onto public balance sheets. In 2007, world governments held 24% of total debt outstanding. In 2011—35%.

“The governments deleveraged the private sector,” Bass said. “Sovereign defaults are imminent in Europe and are the primary concern for investors all over the world.”

The story gets worse when considering MFI (monetary financial institution) assets. “In nearly every developed nation across the globe, MFI assets dwarf sovereign debt. To the extent national governments guarantee bank assets, potential leverage on GDP becomes dangerously excessive,” said Bass.

Already, Iceland, Ireland and Greece have needed massive cash infusions. Spain, Portugal and Italy hang in the balance.

Add to that, Japan. Half of tax revenues now service debt payments, with a declining population to feed the coffers. A 2% interest-rate move would wipe them out, said Bass. “In Japan, the rubber is meeting the road. The jig is up.”

VanLoh warns, “When those kinds of cataclysmic events happen, it’s going to be a shock to the world’s economy like we haven’t seen in 70 to 80 years.”

What about the U.S.? While mired in $9 trillion in debt, the real danger lies in unfunded entitlement programs—Medicaid, Medicare and Social Security, he said. These currently account for 58% of the total budget, going to 100% by 2025. Add another “nondiscretionary” 20% for defense spending, and “we can’t fix the problem if we can’t touch 78% of expenditures. There’s only one way to fix the problem, and it involves some incredibly tough choices.”

Instead, central banks worldwide are more likely to churn the printing presses, leading to global stagflation—inflation of things you need and deflation of things you own. The good news: the oil and gas sector is well-positioned to weather the storm. “If you put a gun to my head and said I could own one thing for the rest of my life, I would own an oil well,” said Bass. “Oil is one of the most tangible assets—other than gold.”