Debt has grown exponentially in developed countries. This growth includes both consumer, corporate and government debt. Debt is supported by collateral assets. Assets grow linearly. To be sustainable, debt cannot grow long-term faster than assets. When there are fewer assets backing up debt, the riskiness of debt rises. Eventually lenders refuse to lend any more. This observation has little to do with economics. It is simple mathematics based on growth rates.
The gap between sustainable debt and actual debt is widening at a frightening pace. For corporations and consumers, there is an end point which markets impose. Markets constrain business and consumer debt expansion in line with collateral and perceived risk. When an entity becomes too risky in the eyes of the lender, lending ceases. At that point debt begins to be liquidated either by pay downs or by default (generally producing a bankruptcy condition).
For governments with printing presses there is no comparable constraint. Politicians could act prudently or central bankers could have the courage to end sovereign credit expansion, but modern political history belies either of these as likely. That does not mean that governments are entirely unconstrained. Markets provide constraints in terms of currency devaluation and inflation. To believe otherwise is to ignore the numerous damaging outbreaks of inflation that have scarred history.
The recent worldwide explosion in money and credit results from bailing out insolvent banking systems and funding profligate governments. For years, every government has been living beyond its means. That is, they spend more than they collect. For years this gap has been closed by government issuance of debt. We are nearing a condition where government is losing trust in the credit markets. It can no longer be funded via taxes and credit markets. Additional government financing, for the foreseeable future, will come via the printing press.
Debt levels are not limited to governments. The chart to the right (click on to enlarge) is instructive. In 1980, total debt in the US was about $4 trillion. In the second quarter of 2009, debt was $50 trillion. It has grown since then. GDP did not grow anywhere near what debt grew during this period. Nor did total assets in the economy.
The chart at the left shows Total Debt as a percentage of US GDP. For most of US history (other than the roaring 1920s), total debt never exceeded 180% of GDP. The 1920s represented another credit boom, similar to the one we experienced for the last thirty years. Debt was unsustainable in the 1920s. Debt levels were resolved via massive liquidations (bankruptcies) and the Great Depression of the 1930s.
Our situation is akin to the late 1920s, only magnitudes worse. There will be a massive liquidation that will result in another Great Depression. That is inevitable, because the amount of debt outstanding cannot be paid down. Economic growth under the most optimistic assumptions will be too slow to allow us to “grow our way out of the problem.” Inflating it away is another solutions that is likely impossible. Rather than face the music, the government will try the inflation route. But inflation is like starting a forest fire and believing you can control it. Once it is started, Mother Nature controls a forest fire.
Inflation cannot be managed and held to some desirable level, especially when it begins to rise. The reason for that is that inflation is a function of both the money supply (one can argue that the government has some control over that) and money demand which the government cannot control. Money demand depends upon millions and millions of people and how much money they choose to hold. When prices begin rising, people begin to accelerate their spending so as to beat the expected future price rises. This causes the velocity of money to accelerate, making the power of each piece of paper and electronic money more high-powered. Simply stated, the government has no control over how much money you choose to hold or how rapidly you choose to spend. It is this acceleration in velocity that turns high inflation into hyperinflation.
One can only hope the the government does not succeed in producing higher inflation because it will wipe out the purchasing power of savings and fixed incomes. That will make people poorer, some even impoverished, when the Depression begins. As strange as it may sound, the best thing the government can do is get out of the way and allow the Depression to begin sooner rather than later. That would allow citizens to go into this dark period with savings mostly intact (and likely growing in terms of purchasing power as deflation results). It would also produce a shorter duration for the Depression.
Politically benign neglect is unacceptable to government. So political decisions will trump personal wealth considerations.
As a result, the coming Depression is likely to be more severe and longer lasting than the original Great Depression. Some have suggested that it will be known as “The Greater Depression.”
The reason for a more serious Depression is the greater imbalance between debt and assets or income than existed at the peak of the 1930s. Today, excess debt represents the equivalent of two years of GDP and continued government intervention will raise this number higher. Peak debt in the early 1930s represented 1.2 years of GDP. Both calculations are made using 180% of GDP as a norm.
There are a couple of other observations worth noting regarding now and the prior period:
- The current credit boom went on for so long and to such excess that the misallocation of resources and prices is likely much greater now than in the 1930s.
- The longer the expansion, generally the longer the adjustment period to get back to normal. If the symmetry between the rise in the 1920s and the adjustment of debt downward through the 1930s has validity, the US is in for a long and extended period of little to zero economic growth. The current period of credit expansion consisted of about thirty years, assuming the expansion stops here. Will the debt buildup be stopped in 2012? If so, will it take us thirty more years to return to normal? If it is not stopped in 2012, how long can it continue?
The government has done everything in its power to prevent necessary debt adjustments from occurring. This strategy may make for good politics but not good economics. By preventing the adjustments, the economy only grows weaker and more distorted. The day of reckoning is inevitable, regardless of what the government intends or wants. As Ludwig von Mises pointed out:
Credit expansion can bring about a temporary boom. But such a fictitious prosperity must end in a general depression of trade, a slump.
For decades, governments around the world have pretended that they are capable of managing the business cycle. Once they succeeded in convincing the public of this lie, they had hoisted themselves upon their own petard. The public, believing this myth, would not tolerate a government that did the right thing — refrained from intervening. Hence politicians are forced to intervene to “correct” even the mildest downturns.
After decades of such “corrective” actions, the economy is riddled with price and asset distortions. There is no other way to clean up these distortions but to allow the economy to purge itself of them. That is what we term an economic correction. Policies to avoid economic corrections only hide the distortions for some period. They are never corrected and others are created. Finally the point we are at now is reached. The massive distortions and mis-allocations are no longer containable, no matter what the government policy or its magnitude. That is when the corrective forces take over and we have a Depression. A Depression is merely scores of minor suppressed corrections that burst forth and happen all at once. That is the point we are at.
The end point is near. Credit needs exceed the supply of credit. The only way the Ponzi scheme can be kept going is via central banks creating ever more increasing amounts of money. Markets place a limit on how much of this credit expansion can occur. As Mises stated:
A fiat-money inflation can be carried on only as long as the masses do not become aware of the fact that the government is committed to such a policy.
Doug Ross discusses how critical the situation has become in the article below. The end, if not upon us, is very close.
Yikes! Total amount of debt that must be refinanced in 2012 equal to… only about all of the cash in the world
The global Ponzi scheme needs some fresh fish new recruits — desperately:
Developed economies will see $7.6trn worth of debt mature this year, with Italy towards the front of the refinancing queue at a time when its borrowing costs remain elevated.
The $7.6trn figure for the G7 economies and the BRICs is up from $7.4trn last year, according to Bloomberg, and comes at a time of slowing global growth and higher bond yields for many countries.
Japan and the US, which will have to rollover $3trn and $2.8trn worth of debt respectively in 2012, saw borrowing costs drop in 2011 as investors fled to safe havens.
But Italy, which remains at the epicentre of the eurozone crisis, has to rollover $428bn this year. This is the third highest amount, followed by France with $367bn and Germany on $285bn.
Italian 10-year bond yields continue to hover around the critical 7% mark, the figure currently standing at 6.88%, and the country had mixed fortunes with two debt auctions at the end of 2011.
But wait — that’s not all!
Turns out that there’s another $1 trillion in corporate debt that must be rolled over this year as well.
All-in-all, the debt loads are becoming awesome and face what Bloomberg describes …. [Continue reading]