Excessive Systemic Debt: The Primary Cause of Our Current Crisis 17 comments
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I don’t know about you, but as a citizen of the United States and a believer in free markets, I find the economic and financial performance of the United States during the last four months shocking. The occurrences of the last four months have strong men and women going home at night and saying to themselves “What the #&%$# happened”. I think I now know “What Happened”. It has been hinted at in Seeking Alpha blogs, published in The Economist magazine as an article buried in the back, not the cover page, but it has not been fully recognized on the cover page of a major magazine or newspaper anywhere that I am aware of. A cover page that says “This is what caused our current economic mess” is what I think most people are interested in.
Look at the graph below (from this Seeking Alpha article - I’m not sure I agree with the article but the graph is what I want you to see) and ask yourself what is striking about it.
What is striking about this graph is that the last time the U.S. had a Debt to GDP ratio close to the Debt to GDP ratio in 2008 was in 1932. I’m not saying we’re going to have another Depression, but it is obvious from the graph that severe economic dislocation happens when the Debt to GDP ratio goes above 300%.
You can talk about bank regulators falling asleep at the switch, you can talk about Countrywide selling any lousy mortgage contract they could to Fannie/Freddie, you can talk about Wall Street greed, but the United States steadily building up debt levels for consumers and corporations (I’m not sure if the graph shows government debt or not) to unsustainable levels is the primary cause of the 2008 financial and economic tsunami. Too much debt was incurred by too many economic players, and its corresponding de-leveraging process is causing real economic problems in terms of falling aggregate demand (think car sales) and unemployment.
There is an excellent David Merkel article that discusses this, although I have to say that the title of his article ("We Have a Debt to Discharge") masked the true importance of what he was saying.
This quote summarizes his main point:
The Great Depression ended when the Debt to GDP ratio dropped below 150%. When enough debts were extinguished by payoff or default, the system could once again be normal.
What is the take away for investors in this? ETFs for indexes, like SPY, DIA, QQQQ, and VEU, and almost every other long investment have suffered badly during the last year. This Total Credit Market Debt to GDP ratio is something to pay attention to and one should get very nervous if it goes over 300%. Seeing the Debt to GDP ratio get back to more normal levels should be an indicator that Main Street is recovering. Ned Davis Research seems to track Total Credit Market Debt to GDP, but I don’t know if it costs money to access the credit information or not.
Another irony in all this is that the government bailout that is the supposed remedy for all our problems will be financed by borrowed or printed money. I’m not hearing any politician say that bailout should be financed by cutting the defense budget by 4/5 ths, or giving up Medicaid. It makes one nervous.
Disclosure: The author has been long too long SPY, DIA and QQQQ
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This article has 17 comments:
your analysis is correct
seekingalpha.com/artic...
here is same chart published several months ago
From the chart Normal Debt to GDP is around 150%. We are now at 350%. OK total US debt is then in the range of $50Trillion and about $30Trillion needs to go. This debt ratio can be reduced by Default, Inflation, or Cancellation. This bad debt came from Retirement Savings being pooled and loaned. But there were not enough qualified borrows, so we got sub prime. As socrateazz says many companies and families have borrowed to pay current expenses and used newer debt to make payments on older debt. Bottom line is on average consumers and businesses are insolvent and mathematically can not pay their bills. It will not help to bailout banks and car companies if consumers can not, should not, and will not borrow more or buy new cars.
If they inflate fast enough, we will get hyperinflation
If they do nothing, the world economy will grind to a halt and food will stop moving - Yes that means your food.
The only hope to avoid chaos is some sort of organized debt cancellation - but I give that about 1% odds - odds are 99% we doomed
I predict Dow 4000 and unemployment 20% by The day Obama takes office. The bottom of the Dow could be 2 years away at 1500 or less.
Shorts theme song: "No.. no.. no.. it ain't me babe! It ain't me you're looking for.. babe!"
There is a recent article in the Time magarzine that talks about the corrupted public school of DC, with lots of apparent problems of school principals who would not administer, teachers who would not take responsibility or who have no abiity to educate, students who would not study, - - - .
The debt is the result of not being accountable, not accountable to oneself.
birder: Appreciate your comments about the chart values. One reason 1932 debt to gdp was so high is that gdp dropped 40% from 1928 to 1932, not happening now, thank god. with this chart i don't even see a 300% peak in the 1930's. But I'm pretty sure Merkel in another article and the Economist sited 300% as the danger threashold so I stuck with that.
Jet: Thanks for pointing out the other article. One reason I wrote this article even though I felt others could describe it better than I is, in my opinion, the statement that debt is the cause of our problems should be page 1 news. Time/Newsweek/Economis... should devote a whole issue to it. Why? I think the whole tone of the Presidential debate would have been different if one of the candidates had correctly identified why we are in the mess we're in. Obama said Bush Deregulation was the problem, McCain said earmarks, dependence on foriegn oil and predatory lending was the problem. If a candidate had correctly identified the primary cause of the change from spring 2008 where most areas of the country had less than the natural rate of unemployment to November when people were seriously asking if Depression II was in the cards, I think everyone would have felt a whole lot better.
Jet, can you expand on "organized debt cancellation", it sounds like an intriguing idea. Or better yet, write an article on it.
Responsibility: "Is the huge debt the symtom or the illness?" Interesting question. Is it a flaw in free markets if all (in a statistical sense) economic players in the economy decide simultaneously to borrow too much money? Does a fractional reserve banking system allow unlimited lending or was there something about the U.S. status as an economic super power that somehow allowed it to borrow too much money?
International Readers: I don't think this is a U.S. problem only. I have no data to prove this but I think U.K., Spain, and Ireland are in a similiar situation to the U.S. in terms of debt to gdp. I think i even read somewhere that u.k. might be worse than the u.s.
The Fed and the Treasury were convinced that they needed to prop up the counterfeit money with injections of cash and loans. But it won't work, someone has to pay for the injections. The banks go right to the consumers wallet to pay for their loans or the tax man goes to the consumers wallet to compensate for bad loans, like-wise businesses. The consumer wallet has been drained.
Banks make money by lending or facilitating lending using various devices. The debt graph simply indicates something is wrong with the money supply. You have unsound lending backed by CDS protection that is fictional, leveraged 100 to 1. There are deals in the shadow system that have yet come to light.
The Treasury and the Fed are now trying to to protect Main Street by by-passing the big banks. No one trusts the big banks, it is not business as usual, so the government is the only game in town when it comes to generating banking fees. Right now those fees are connected with low interest rate mortgages. Instead of giving banks money, they are making them earn it. This is one plan that may actually work. The big banks will be forced to divest or downsize to respond to demand for their services. The big banks proved to be such lousy risk managers that by having the government manage the risk, the banks can crawl out of the hole they dug. The mortgage loans better be sound.
DRI: The accuracy of the graph is of obvious importance. It's hard to believe with all the changes between the 1930's and now the graph is truly apples to apples. One would hope it's the sum of all retail mortgages (counted once), the sum of all credit card debt, the sum of all auto loans, the sum of all corporate debt, etc. .... . One would assume that the Economist checked this out pretty carefully before publishing it. I apologize, I searched the Economist web site to find the article I read and couldn't find it. I'm not absolutely sure that the Economist puts all it's print articles on the web. This is my basic assertion. Debt built up incessantly and to unsustainable levels until the bubble popped (probably subprime was the pin) in fall of 2008. When the bubble popped, all hell broke lose. Major companies went broke, all manner of debt (credit cards, auto loans, student loans, mortgages, etc) had major problems. And now we are faced with fixing the problem. One reason I think we are on to something here about debt is these are the only two times in 80 years that had this level of problems. You didn't see debt to gdp go to 300% in 1984 and there were no problems. But your point is well taken, if the graph doesn't show what we think it is showing, that is a problem.
There would not have been any money to make subprine loans if not for the flood of money. Same goes for all the securitized "derivatives" sold and repackaged, sold and again repackaged.
Artificially low interest rates distort and ruin the market. Savers can't get a decent return and buyers get to fulfill every greedy desire with little IMMEDIATE penalty. Unfortunately, there comes a time of reckoning and we are there. The Federal government hasn't realized it yet - they are still "creating" money out of thin air and lending it essentially for free (but only to their buddies on Wall St ). The rest of us get their credit card interest rates doubled, credit limits halved and cash advance limits slashed.
The cheap credit bubble is the cause of this entire mess. Subprime loans and ted spreads are just symptoms caused by the problem.
It will get worse as long as the idiots in DC keep the cheap credit floodgates wide open.
Flooding the u.s. with money: By saying this I assume you mean that as Chairman of the Federal reserve he increased the money supply. If he increased the money supply that would cause inflation. I don't think inflation ever went over 4.5% on Greenspan's watch so I don't think he created too much money. Some people like Steve Forbes say that the Fed flooded money into commodities. Inflation is a general rise in the overall level of prices. If one price rises (oil) there is less to spend on other items. So I don't buy the flooding argument, either overall or into specific areas. Unless you are saying that kicking inflation from 2% to 4% created the 30 trillion excess debt that Jet talks about above.
He kept interest rates too low for too long: He kept the fed funds at 1% for a long time. I believe that markets set interest rates. The Fed can have some influence for a short while but not for more than 6 months in my opinion. I have seen fed funds and short term treasury/libor rates diverge by a lot. If the fed chairman wanted to make corporate bond rates lower by 2% for 5 years into the future, I don't think they have the power to do that. If they print money, and cause inflation, people figure that out and start adding an inflation premium into their demanded interest rate.
To get to the excess borrowing that we are are talking about two things have to happen. economic players have to borrow to much money and the financial instutuions have to be able to lend the economic players that money. axelrod608's comments and my response to them are a discussion of how financial institutions might be able to lend too much money.
1) Wealth creates the thinking 'hmmm, how shall we make human progress' but seldom do politicians conduct deep forecasting of the cost.
2) Debt is created to fund point #1. A lot of politicians mean well but are economically illiterate. Then there are a small percent that legislate into there own pockets, allow looting of treasury and exacerbate an already bad situation.
3) Depression occurs with the money supply shrinking to 30-40% over a four year period. Imagine if you and a couple friends were used to eating out with $100 and now all four of you have $40. We are at the start of the depressionary phase.
4) Innovation creates technologies and effeciencies. Private capital pulls double duty. Citizenship rids itself of 30% of it's House of Representatives incumbants, also called Voter Revolution.
The mistakes already made and the amount of money already spent or guaranteed have also guaranteed we are a) Japanese economic recovery b) The reinflation attempt and $2T already printed will create runaway inflation and a new recessionary phase very W shaped. But I am still long America.