Category Archives: Debt

Same Old

The Fed is making clear that it is having a change of heart and rate increases are on hold for the time being.

Does this mean the all clear, the bull market can resume? No. This is not good news. It means that even the Fed can now see the recession coming and is trying to avoid the blame. The recession itself is inevitable. The light at the end of the tunnel is a train and no amount of panicking will change that.

Powell was the last hope for a truly independent Fed. Well forget that. It turns out he’s just another politician. Go back to your cherished memory of Paul Volcker and resume dreaming. I quote the IMF, which may not know economics but does know accounting:

“Global debt has reached an all-time high of $184 trillion in nominal terms, the equivalent of 225 percent of GDP in 2017. On average, the world’s debt now exceeds $86,000 in per capita terms, which is more than 2½ times the average income per-capita.”

This catastrophe belongs entirely to the world’s central bankers and the governments that have failed to constrain them.

Fair Tax

There’s much whining that Trump’s tariffs are going to be paid by the U.S. consumer in the form of higher prices for imported goods.

That’s right. And that’s a good thing. Trump has lowered income taxes and needs another source of revenue to compensate. Tariffs, in effect, are a form of consumption tax.

Back in 2009, I blogged my recipe for diverting the nation from the financial disaster now awaiting us. I fear that it is too late, but the first bullet on my list was:

Rebuild the nation’s balance sheet by encouraging savings and penalizing consumption. The primary tool for doing this would be the replacement of the income tax with a consumption tax.

Unfortunately, it is far too late. But replacing income tax with consumption tax is the right thing to do. And yes, I am aware that penalizing consumption will, well, reduce consumption. That’s OK, especially if it reduces the number of huge testosterone-fueled black pickups.

Close To The Event Horizon?

From ECRI’s Lakshman Achuthan:

Notably, the combined debt of the US, Eurozone, Japan, and China has increased more than ten times as much as their combined GDP [growth] over the past year.

Remarkably, then, the global economy—slowing in sync despite soaring debt—finds itself in a situation reminiscent of the Red Queen Effect we referenced 15 years ago, when tax cuts boosted the US budget deficit much more than GDP. As the Red Queen says to Alice in Lewis Carroll’s Through the Looking Glass, “Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!”

Credit Impulse

The credit impulse isn’t the sudden urge to borrow – it is the additional income and concomitant spending that results from an increase in aggregate debt. Spending capacity = net income + credit impulse. Credit impulse (annual) = current debt amount – year ago debt amount. Not complicated.

The credit impulse is how easy money creates economic expansion as economic entities – households, corporations, governments, etc. are able to spend more than they earn.

The downside is that, sooner or later, the entities reach the limit of their ability to borrow. The credit impulse disappears and the economy shrivels. Incomes diminish and defaults begin as entities can no longer service their debt. Credit becomes very difficult to obtain, lenders fail as capital losses mount and the economy accelerates downhill as the credit impulse goes negative as borrowers are unable to roll over their debt.

Credit Impulse

US household debt ended the year at $13.15 billion, a y-o-y increase of $402 billion and a record. This means that about 2% of GDP came from the increase in household debt alone. It is likely that when corporate and government debt increases are taken into account that the economy is operating at a substantial loss.

Fed Minutes

Another day, more blather from the Fed. Risk is “on” with a vengeance as the Fed continues to demonstrate its unwillingness to “take away the punch bowl” as Fed Chairman Martin put it.  Apparently there is no such thing, in their minds, as too much stimulus. We’ll see about that. In my view, a financial catastrophe is almost inevitable at this point. Overpriced stocks and the fear of inflation have always been a toxic mixture. Add in the overhang of aggregate debt somewhere in the neighborhood of 350-400% of GDP and you have a recipe for a protracted decline to well below fair value, unlike 1987’s brief shock.

 

Universal Basic Income

The left continues to be fascinated with the idea of re-distribution. It believes that the whole notion of some people being paid more than others is fundamentally unfair, that they must have had some advantage – skin color, parents, brains, whatever – which was just a matter of luck. “You didn’t build that,” as Obama famously said.

So the latest brainchild of this idea is the notion of a monthly check from the government that is sufficient to provide a comfortable lifestyle regardless of whether or not the recipient chooses to work.

A single program that replaced the myriad of transfer payment programs, from welfare through Social Security, would save an enormous amount of administration costs at all levels of government and help to pay for the program. The “poverty trap” would be eliminated as the payment could be “universal” that is, not means tested. Minimum wage laws would need to be abolished, of course, since the “living wage” would be redundant. Might not work, but there seems to be some potential anyway.

But that is not what is proposed. In general, it seems that this would be yet another program which would be funded by even more government borrowing. This, it is claimed, would “grow the economy by $2 trillion.” Please.

There are only two ways to grow the economy. One of these is to increase labor utilization, the number of hours worked in a given period. The other is to increase the productivity of that labor, that is the amount of output produced for each hour of labor. That’s it.

Existing programs already provide a major disincentive for work – the “poverty trap.” This would add another. Productivity is improved by investment – in technology, skills, infrastructure, etc. More spending on consumption would not help this, but would certainly provide more inflation, which would act to deter investment. If you want to see the outcome of this kinf of program, just check the news from Venezuela.

 

 

Government Shutdown?

Many voices are being raised to warn of the danger of a government “shutdown” should Congress fail to raise the debt limit.

Why, one might ask, is this so dangerous? It is simply the fact that U.S. Federal deficit is still running about 3% of GDP. Cut Federal spending back to match its income and recession will certainly ensue.

Of course, the steady accumulation of debt is even more dangerous, but less immediate. So the voices hope.

A “shutdown” would not need to be anything more than a modest 15% reduction in run rate. Inconceivable.

Unexpected Outcome

People seem to be surprised that the Fed’s rate hikes have resulted in rates declining. Really? It seems pretty clear that the Fed’s outlook is at odds with reality, and that rates are responding to the real outlook, which is that Fed rate hikes are a negative for an economy that is already tanking.

The Future Is Now

Debt pulls demand forward in time. Borrowers use debt to pay for consumption today and commit future income to service the debt.

The amount available for consumption today represents the present value of that committed income, discounted by the prevailing interest rates.

The further that borrowers reach into the future, the more that discount lessens the amount available today. The Fed wants consumption today, so it attempts to induce inflation in order that borrowers are more confident of their future nominal incomes, while holding interest rates low so that the discounting of that income is minimized.

This strategy has sustained consumption in the short term, at the expense of reducing future income available for consumption.

The problem is that the future is now.

As consumption slows, so does production and inflationary pressure. Defaults rise – just look at the subprime auto loans. Yes, defaults eliminate debt – but only at the expense of the creditor who takes an immediate hit to income, charged against net worth or equity capital. Lenders are forced to reduce their assets.  Borrowers find that debt service takes more of their income than they had expected. Purchasing power erodes and deflation sets in. Spending capacity falls even more rapidly and the economy slides into recession and depression.

The larger the accumulation of debt, the longer it takes to purge the financial system and restore it to stability. Debt – credit – is a necessary and healthy part of the economic system. But the economy cannot depend on consumption funded by the continuous growth of debt. Debt must revolve, expanding and contracting within limits proportional to the size of the economy.