Can a Fed Move Stop the Debt Supercycle?

Friday's economic reports showing softness in U.S. employment and industrial production fanned recession fears and hit stocks hard, but an aggressive easing of monetary policy is expected to rally stocks -- especially emerging markets and U.S. large-caps -- once the usual fretting and handwringing subsides. That, in a nutshell, is the kind of scenario the Bank Credit Analyst advisory seems to be espousing.

It’s not that Federal Reserve Chairman Bernanke is such a nice guy but that the “Debt Supercycle” will force the Fed’s hand, starting with a likely 50-basis-point cut in its key lending rate at the institution’s rate-setting meeting on Jan. 30. The term, “Debt Supercycle” is attributed to the BCA advisory, which has chronicled the rise of U.S. debt in one of the scarier charts to be found on the long-term prospects for the U.S. economy.

You’ll find it on page 3 of the document, An Inflection Point in the Debt Supercycle (although this particular portrayal downplays the uptrend with a longish horizontal axis). It shows U.S. non-federal debt as a percentage of GDP from the 1970s to present. As can be seen, the percentage of debt to GDP has been cycling ever higher – from 100 to 180 (with the surge since 2000 quite startling).

What this means is that there is a real capacity for a major economic implosion if market forces are left to unwind on their own. A debt-deflation spiral like the Great Depression of the 1930s is a possibility even -- unless the Fed responds quickly and dramatically (as it likely will) to stop the economic multipliers from gathering downward momentum.

There will be the usual fears over “pushing on a string,” and deflationary vortexes but the history of the Debt Supercycle and Fed policy indicates the latter wins out. Besides, there is still plenty of scope for a policy response of sufficient magnitude thanks to low consumer price inflation, aided by fiscal re-stimulation (federal debt is still relatively low at less than 40% of GDP), and a falling dollar.

The side effect of staving off another financial Armageddon will be another upleg in the Debt Supercycle and bubble-like episode (BCA’s picks emerging stocks and U.S. large caps as the favored assets). But this leaves one wondering where it will all end. Debt can’t keep rising relative to income forever. Perhaps the doom-and-gloom prophets will be right eventually about a supernova-like trauma. I don’t look forward to that at all.

Comments

[HARM:]

"federal debt is still relatively low at less than 40% of GDP"

I would not place too much faith in this stat --this is regularly trotted out by cornucopians and Wall Streeters as "evidence" that U.S. government debt is not that high by historical measures. However, it fails to account for the fact that much "government debt" in the U.S. is in the form of STATE and MUNICIPAL debt --and is not reflected in that 40% federal-only figure. In other countries (Eurozone, Japan, etc.), no such distinction is made. They include all government debt --national and local-- in their stats.

We should be comparing apples to apples, but as the saying goes, "lies, damned lies and statistics."

2008 Jan 07 02:59 PM

[eponymousLTC:]

I concur with HARM with the inclusion of "lies, damn lies, and US. GOVERNMENT statistics". Saddam Hussein's Minister of Information seems more trustworthy.

2008 Jan 07 03:13 PM

[vboring:]

can a Fed move stop the debt supercycle?

probably.

though, the more important question is if we want them to.

it seems the market is calling for the Fed to cut rates to encourage businesses through ever-increasing indebtedness. if we're lucky, another bubble will inflate to save us, probably in the health care or renewable energy industries.

but, do we really want to go down this path, knowing that we're just making the problem worse?

2008 Jan 07 03:33 PM

[David Schrader:]

Mortgages are not based on the Fed Funds rate, they're based on LIBOR which is still fairly high. If we truly wanted a solution to the current crisis we'd be pressuring Europe to lower rates.

We can not keep overspending as we have. The jig's up, America.... let's take our medicine and be done with it.

2008 Jan 07 03:35 PM

[Reinko:]

Interesting article, yet the chart nr 1 as mentioned in the pdf file that was linked to:

www.beearly.com/pdfFil...

says that non federal debt is 180% of the gross domestic product.

Well, according to the 'flow of funds' sheet from the Federal Reserves Z1 release

www.federalreserve.gov...

says:

Total non financial debt sector = 30640.9
Total financial sector debt = 15435.3 billions of US$.

Thus over 46 trillion and therefore over 300% of GDP.

So the pdf article is crap because even on the flow of fund release not all debt is collected...


To Harm I can say:

All emergency spending is also not in the 'official' debt, for example the wars in Iraq and Afghanistan and hurricane Katrine costs are not in the deficit.
And there is another big hammer that is not included: Federal Agency bonds are not included.

So it has been proven that total debt that the US economy has on itself is above 50 trillion and just the interest on that mountain of debt is something like 18 to 19% of the GDP.

18 or 19% of the GDP is needed to stabilize the debt (read pay the interest) and is above total profits of the US economy...

Weighing all in all, the above article is not very good and not carefully thought through. A pity...

2008 Jan 07 04:35 PM

[Reinko:]

There is more validation that this author Larry MacDonald often has his home work not on order.

Read his article Another Housing Bubble to Short, link:

seekingalpha.com/artic...

From that article we have, quote:

House prices in this European country are in an enormous bubble. Over the past ten years, they have soared 200% (according to the Ministerio de Vivienda). By comparison, U.S. house prices have climbed a “mere” 80% over the same 10 years.

Unquote.

Well isn't the famous Case Shiller housing index the one that is often named when talking about US house prices? There are a whole lot of them but they are all about 10 years old.

Isn't it a well known fact that the top the the S&P CS index was 260?

Thus 260% over the past 10 years?

This Larry guy gets more funny the longer you read him, yet as a source of significant investor inshight he is not very reliable. But when you want to have a laugh every now and then, here is his collection of writings:

seekingalpha.com/autho...

Have fun!

2008 Jan 07 04:57 PM

[HARM:]

@Reinko,

Thanks for the info -- do you have any links with tallies/estimates for off-budget 'emergency' and agency debt?

2008 Jan 07 05:01 PM

[Reinko:]

No Harm, I am sorry but I keep looking since 2004 for reliable sources of information on that kinds of debt but nowhere are reliable sources found.

For example, in a normal world the Federal Reserve would also publish the totals of emergency spending but the don't do that.

But at the Russ Winter blog you can find a lot of folks that often have good details and sometimes good statistics, here is a link:

wallstreetexaminer.com.../

Russ is very good but sometimes a bit 'over the top', but his rants are fun to read.

As far as agency debt concerned: All I know it was very big in the nineties when it sometimes the size of the official federal debt, but in the 2000+ years you do not hear that much from it any more.
(But it's likely still big.)

I only have a link for may be Agency bonds parked at the off balance Federal Reserve stuff (scroll below to you see Memo (off-balance-sheet items) and 'Federal Agency'.

Likely that is some collateral exchanged for money, but the Federal Reserve is alsways a bit vague on stuff like that.

2008 Jan 07 05:35 PM

[Reinko:]

Oops: here is the link:

www.federalreserve.gov.../

2008 Jan 07 05:37 PM

[Solution:]

Looks like everyone will correctly call the coming bear market.

2008 Jan 07 08:02 PM

[Lawrence York:]

Reinko, David Walker US Comptroller General has put together a power point detailing current on-balance sheet debt. You are correct with your $46 trillion dollar number. Iraq war spending, unfunded state & local pension liabilities are not in it, the coming tab for the housing debacle that will hit GNMA and Freddie Mac are not in it, nor is social security as the government now has cleverly cancelled all those IOU bonds by recasting SS as a 'pay as you go' system. Get Walker's powerpoint at: www.gao.gov/cghome/d06...

2008 Jan 07 09:14 PM

[calvino:]

MacDonald assigns the Fed powers it does not have. Although it can lend money to member banks, it can not force them to relend the money. It can recapitalize the banks by giving them short term notes and letting them buy long dated Treasury paper, however that is snakes eating their own tails. Unless the money is going to capital creating enterprise. He mentions an alt energy bubble, however in completely wrong context of a bubble. That is capital creation. Consumer goods is not - that is a snake eating its own tail. The Democrats gave us the last staw to clutch at with the renewable energy bill, however the Senate filibustered it to death. Read it and weep.

2008 Jan 07 09:45 PM

[ballsschweaty:]

Prechter has been calling for the Grand Supercycle Top for over a decade now. A determined federal reserve can avoid a deflationary debt collapse and they will likely avoid it once again.

Green pieces of paper with numbers and Presidents pictures have no intrinsic value.

The continued erosion of the American standard of living will be achieved by perpetual devaluation of our currency.

Prechter was probably right when he called the Grand Supercycle Top. He just chose the wrong measurement metric.

2008 Jan 08 12:34 AM

[Reinko:]

To SeriousBull: Thanks for the pdf file, a lot of it I already knew as for example all those trillions of US government bonds that are in the Social Security funds are only used as a mechanism to lower the official debt.

It makes you wonder: why do they do that?

And the answer is amazingly simple: The break down of the old 'checks and balances' system is mostly found in the far too simple two party political sytem in the USA.

This is multiplied via the fact that US Presidents have to be someone that 'people can relate to' so some average six pack Joe will always win the elections. A guy like the former central banker also has to be some guy that 'people can relate to' and we all know what damage Alan has done...

But facts are facts and this year the total debt of the US economy on itself will pass the 50 trillion threshold and thus at an interest level of 5% this economy needs over 18% of her GDP just to pay for the interest.

Conclusion: Like all other fiat money systems this will crash.

It is sad that it is this way because good policies from the central banks could have prevented such a crash but now it's too late.

2008 Jan 08 05:21 PM

[flow5:]

There will come a time (unpredictable) when it will be impossible for the government (federal) to collect enough in taxes to pay all of its expenses, including interest on the national debt. The Gov't can of course borrow an indefinite amount through the Fed. (concealed greenbacking) given a few changes in existing law. But that would lead to hyper inflation - i.e., a collapse in the credit of the Gov't. So the easy way, is the way the French did it in 1960. Simply say that beginning Jan 1 (or any other date), new dollars will be issued, and that each new dollar is worth 100 old dollars. Then follow that up with a largely state controlled or a command economy.
France did this in 1960. The Rueff committee (headed by French economist/mathematicia... Jacques Rueff, a neo-liberal), during Charles de Gaulle's presidency, replaced of the old franc by a nouveau franc equivalent to 100 of the old. However, inflation continued to erode the currency's value, but at a greatly reduced rate comparable to other countries. With the introduction of the Euro, the franc in January 1, 1999, was worth less than an eighth of its Jan. 1, 1960 value.
The French franc, which once was one of the weakest of currencies, overnight, became one of the strongest. In recognition of the rebound in the French economy (owing to the Rueff plan, which included sweeping measures to balance the budget, stabilize the currency, and eliminate exchange controls), the government issued a new franc equal to 100 old francs on January 1, 1960, or 20 cents to a U.S. dollar. The old rate was 5.00 to a dollar. The gold content of the franc was increased a hundredfold, and rates of exchange immediately reflected this change, as did internal prices. Internally, prices dropped about 90 per cent, and on the foreign exchanges the franc rose after revaluation from approximately 0.238 cents per franc to around 20.389 cents per franc. Internally, as noted, France was on a managed paper standard; externally, on a modified gold bullion standard. Because of the strength of the French economy, the franc became fully convertible at or near its gold par into gold for foreign exchange purposes, and into foreign currencies.

2008 Jan 10 02:23 PM

[flow5:]

Those who are wont to minimize the ill effects of the deficit are prone to compare the size of the deficit with nominal GDP, as if the volume of nominal GDP were independent of the size of the deficit. Unprecedented large deficits “absorb” a disproportionately large share of nominal GDP. Present deficits are unprecedented no matter how measured, and the past gives us no reliable guide to the future effects of deficit financing, beneficial or otherwise.
To appraise the effect of the federal budget deficit on interest rates, it is necessary to compare the deficit, not to the debt to GDP ratio (a contrived figure), but to the volume of current savings made available to the credit markets. The 2006 deficit (406 billion interest expense) is absorbing about 23 percent of gross private savings. FY2006 total debt is the sum of: federal and state & local governments, international, and private debt, incl. households, business and financial sector debts, and federal debt to trust funds (50.5 trillion).

2008 Jan 10 02:25 PM

[dae:]

Back to the future. Alert. Oct 2008. Implosion has happened.

2008 Oct 10 12:14 AM