The Debt Culture: Land of the free, home of the indebted
By Tony Allison, November 10, 2008
Over the last 40 years or so, the American economy has evolved from a manufacturing-based economy, to a service economy to a financial economy. All along the way, the levels of debt (personal, governmental and corporate) have continued to grow as new and creative forms of financing and leverage permeated our economy. We have now reached a crisis where consumers and business are unable or unwilling to add more debt. As the economy slides into what looks to be a very severe recession, our federal government is now expected to bailout consumers, businesses and state governments to the tune of untold trillions of dollars.
The US is not alone of course, as this crisis has rapidly spread around the globe. China just announced a massive $586 billion stimulus plan to pull China out of its own tailspin and keep its hundreds of millions of workers employed and employ millions more streaming into the cities. China’s growth rate for the 3rd quarter was 9%, down from 11.9% a year earlier. Some economists have predicted a much lower growth rate for China in 2009.
The difference is that China has well over a trillion of our dollars as trade reserves to throw at the problem. This may be an issue when China starts selling Treasury bonds as it begins the stimulus program. As the world’s largest debtor, the US must borrow or simply print the trillions we will need to keep our economy afloat. This has unfortunate consequences. With very negative real interest rates for US Treasury bonds, foreign investors will eventually demand significantly higher rates, or simply stop buying our bonds. And the printing of money, wildly in excess of a country’s growth rate, never ends well. While the dollar is currently the beneficiary of global fears, as well as global de-leveraging, the longer-term fundamentals for the US dollar are extremely ominous. It all comes back to our culture of debt and the piper now pounding on the door.
Source: FRB Flow of Funds/BEA
Source: FRB Flow of Funds
Digging out of the debt culture
The headlines are truly disturbing; our iconic financial institutions failing or suddenly on the brink of insolvency and in need of immediate rescue. The auto industry is likely next in line, followed closely by the airlines. No one knows where or how it will end, but this historic crisis will claim many victims.
How will we ever dig ourselves out as a nation? Frugality and hard work of course, but the debt has reached a level of mind-boggling parabolic progression. It must slow down, and it will as this recession (or worse) continues, at least as far as consumers and businesses are concerned. However, in times of national crisis, government spending will likely speed up. And as a debtor nation, government spending on a massive scale means new debt on a massive scale. Ultimately, the only realistic solutions are debt default to foreign sources (a la Argentina) or rampant inflation to make the future debt payments in much cheaper dollars. Neither will solve the underlying issues of under-production and over-consumption, although this recession will begin the long re-adjustment process. At this point government-generated inflation is more likely than debt default, as long as the US dollar remains the world’s reserve currency.
A protracted depression might also wipe out the mountain of debt, but the cure might kill the patient. Check the chart below in how the 10-year Great Depression brought debt levels back down the mountain. Unfortunately, our mountain of debt, as a % of GDP, has farther to fall. We were also a creditor nation in the 1930’s and energy independent.
Some positive affects of this crisis will likely be the re-industrialization of America. Because of government incentives, peak oil, and the immediate need to create new jobs, industry will begin to reemerge in America. Our infrastructure has needed re-building for many decades, and this crisis will finally get the politicians to act. How it will be paid for is another issue, but at least it will add many well-paid jobs and it will eventually add to our nation’s productivity, which is badly needed for future growth.
Another positive that may emerge from our current morass is that the nation may finally realize how much wealth is transferred overseas through our self-created energy dependence. For many years we have been buying our energy needs with debt, as the Middle East and other exporters re-cycle their petro-dollars into Treasury bonds. Our debt for imported oil could exceed $400 billion this year alone, even with lower oil costs. If overseas bond holders become nervous enough about the dollar, then those bonds may be sold, as the wealth is called back home. A national sense of urgency is critical. If the US begins a crash program to gain energy independence, using all available energy sources and technologies, then the wealth transfer will slow, and eventually stop. It won’t be easy or quick or cheap, but it will create millions of jobs and a sense of national purpose.
Source: Bureau of Census
Since the media is drawing so many comparisons with the Great Depression these days, perhaps we can draw upon some of the lessons of that era as well. Out of that devastating period an entire generation was sufficiently chastened to subsequently follow the tenants of thrift, hard work, and caution toward debt. The debt culture of the time, resulting from the easy money of the 1920’s, was shattered. Unfortunately, we may be destined to learn many of the same painful lessons 75 years later.
Where do we go from here? Back to the future. Retrenchment. Living with less; smaller homes and cars. We may see multi-generational families living together again out of necessity, much like America of by-gone days. This may actually help bring our culture closer. Our society will see much less consumption, more saving, and best of all much less debt. However the debt burden we now all share will not be easily resolved and will likely be our “legacy” for future generations to solve.
A phrase we may begin to hear from the new Obama Administration is “shared sacrifice”. We only hear about sacrifice from politicians in times of crisis. This time certainly qualifies, but the call is years late in coming.
If the pain and sacrifice can truly be shared (or at least perceived that way), then Americans will tighten their belts and get to work re-building our country. If secretive deal-making and class-warfare bickering prevails, then the healing process will stall and progress will be a slow, painful slog.
America may be at an historic crossroads, not just muddling through a garden variety recession. It is my sincere hope that out of these difficult times will emerge a wiser, stronger and more united nation.
US stocks finished lower on Monday, sending the Dow Jones Industrial Average back below 9,000, after early enthusiasm over China’s economic stimulus package faded in favor of ongoing worries about US companies, including General Motors.
The Dow Jones Industrial Average fell 73.27 to close at 8870.54. The S&P 500 Index was down 11.78 to close at 919.21. The Nasdaq also closed lower, ending at 1616.74, down 30.66.
Crude oil futures closed more than 2% higher Monday after a volatile trading session that took prices briefly below the $60 level for the first time in 20 months, as traders gauged the potential for increased energy demand from China, which announced a $586 billion stimulus plan.
Natural gas was the biggest gainer among energy futures, with prices climbing more than 7% as traders eyed increased demand for the natural gas during the winter heating season.
Gold futures pulled back from near a two-week high Monday but still closed up more than $12 as China's economic-stimulus package helped fuel gains among most commodities.
Wishing you a good evening,
© 2008 Tony Allsion