Archive for February 7th, 2013
The United States of Debt Addiction: Our reliance on debt has created an entire economy fortified in the fires of moral hazard and fiscally dangerous leverage.
16 point 7 trillion dollars. That is our current national debt. 12 point 8 trillion dollars. That is the amount households carry in mortgage and consumer debt. We are now addicted to debt to lubricate the wheels of our financial system. There is nothing wrong with debt per se, but it is safe to say that too much debt relative to how much revenue is being produced is a sign of economic problems. At the core of our current financial mess is how we use debt as a parachute for any problem. We’ve been masking the shrinking of the middle class by allowing households to take on too much debt for a couple of decades. The results were not positive. Too this degree, we have now created a massive moral hazard economy where savings are punished into oblivion. There is very little incentive to put your money in a bank account yielding zero percent interest when real inflation is eating away at your money like a hungry wolf. So what do people do? Well many simply cannot save and therefore choose to go into debt to finance cars, housing, and education with very little down. Where does this debt addiction lead us?
A little bit of deleveraging
US households have deleveraged from the peak in the crisis. However, much of this deleveraging has been forced via the 5 million foreclosures that have occurred:
I’m not sure if we can interpret that as some sign of a healthy and growing economy. Households have had their access to debt limited in many sectors. Yet one sector that never retreated was that in higher education. There is little doubt that there is a major bubble in higher education. Instead of addressing the problems head on we now have more access to debt as the solution. In order to compete in our service driven economy, having a skill is very important. Most will make the investment to pursue a college degree but the issue is that with easy access to debt, prices have soared. It is no surprise that college prices are following the trajectory of what happened in housing.
If you look at the above chart, a big part of the contraction has come from deleveraging from mortgages and credit card debt. Yet we are now once again loading up on auto debt and college debt. The system is now setup to punish any type of savings. Good luck trying to stash your money in a bank account and outrun even the steady pace of inflation.
Take a look at the current savings rate for Bank of America:
Of course the Fed has a hand in all of this. The Fed realizing that our system for over a decade has been juiced by debt spending, had to step in and make it unattractive to save to the point that people are willing to dive into risky investments yet again. Because of this however, you create moral hazard.
Read the rest at My Budget 360
The New Nasty: 1% Deficit Upper Bar
Nonfarm business sector labor productivity decreased at a 2.0 percent annual rate during the fourth quarter of 2012, the U.S. Bureau of Labor Statistics reported today. The decrease in productivity reflects increases of 0.1 percent in output and 2.2 percent in hours worked. (All quarterly percent changes in this release are seasonally adjusted annual rates.) From the fourth quarter of 2011 to the fourth quarter of 2012, productivity increased 0.6 percent as output and hours worked rose 2.4 percent and 1.8 percent, respectively. (See chart 1 and table A.) Annual average productivity increased 1.0 percent from 2011 to 2012. (See table C.)
The reason this is much nastier than one would like is that in the long run budget deficits on a sustainable level are inevitably tied to productivity improvements.
If economic output is improving in efficiency at 3% a year then you can have a budget deficit of 3% and the system will remain in balance. The government is essentially stealing the productivity improvement of the people, and this is wrong on an ethical and moral level, but it is mathematically stable.
The Euro Zone, for example, has a hard budget deficit cap of 3%. This has been routinely ignored and gamed, which is largely responsible for the mess they’re in today, and in fact the risks there are grossly under-appreciated (and likely to become realized risks soon enough!)
But here in the US I have believed for quite some time that we would be maintaining a rough 3% improvement in productivity over multi-year periods. This report throws cold water — and a warning — on that expectation, as it is the second year running that productivity has run at 1% or below.
This has a profound impact on sustainable deficits; if you can run a 3% deficit then on a $15 trillion economy you can run a $450 billion deficit on a long-term sustainable basis. Again, this may be immoral and theft, but it’s mathematically stable.
With a 1% productivity rate you lose $300 billion of that spending; now you can only run a $150 billion deficit. And this is the second year sequentially in which productivity has run 1% or less.
Should productivity go negative it gets even worse; you are then forced to run a surplus to remain in monetary balance.
The target, unfortunately, has to be moved to a 1% deficit from 3%.
And incidentally, that’s three times the size of the sequester in terms of the change required — and it has to be made right now.
A glance at headlines over the past few months and there is little mention of anything but Europe’s periphery struggling but market performance implying that a turnaround is about to occur. Most of this is based on a belief that the core is doing ‘well’ and that the periphery is gradually becoming more competitive. However, as if elections were not enough to worry Frau Merkel, it turns out, as Diapason’s Sean Corrigan notes,Germany’s Industrial Production, stymied by a surging EUR, has just suffered its third biggest quarterly decline on record - plunging back to 2007 levels. Furthermore, France’s Industrial Production is back at levels first seen in 1997 – also plunging (perhaps explaining Hollande’s recent exclamations at EUR strength); as the core is starting to soften significantly.
The WSJ has an interesting opinion piece this morning that should be required reading — but it won’t be by far too many of the political wonks.
In a 1996 speech to the American Enterprise Institute, Federal Reserve Chairman Alan Greenspan famously warned about the dangers when “irrational exuberance” fueled asset inflation. By that he meant that rising values of stocks and real estate might reflect only a cheapened dollar, not an increase in their real worth. Since he was the man in charge of the dollar, his remark caused quite a stir.
We’ve learned a lot about asset inflation since that speech, but maybe not enough. The nearly 2,000-point rise in the Dow Jones Industrial Average since last June no doubt at least partly reflects asset inflation, since there has been very little in the economic or political outlook to justify it.
Actually, we’ve learned exactly nothing, save one point — politicians love asset inflation, and the more they can stoke it the more they love it.
The reason is simple — it gives them something to point to as a so-called “measure” of economic health, they get to tax it, and it is something they can twist knobs on in the monetary and fiscal policy realm to pretty-much dial up — most of the time.
This leads political sorts — and central bankers — to deduce that such is “free.”
But nothing is ever free.
Unbacked credit issuance is exactly identical to currency printing in economic terms. And our history since the 1980s has, unfortunately, been to abuse monetary and credit systems as a means of covering up our desire to borrow and spend more and more to keep up the chimera of so-called “economic growth.”
This isn’t a “new” problem; our economy in the United States has put on roughly 3% in new credit above the rate of GDP growth since records became reasonable-available in enough detail to analyze — which dates to the 1950s.
Now take a look at this graph (again):
That’s the credit and GDP expansion quarter-by-quarter. The modeling of it in terms of levels (as opposed to flows) is roughly this:
For those who think this isn’t what our debt picture looks like in the above, uh, well…
Now notice that since 2009 the pattern has changed. That is, while we have fits and starts of credit creation net-net, we can no longer maintain it. The markets are at present responding to what they believe is the old paradigm — but that paradigm no longer exists.
Instead, what is happening is that as the Federal Government becomes the only issuer of this new credit (and the Fed the only market sink) the impact shows up in reduced purchasing power that disproportionately falls on the lower and middle classes, since the economy in general refuses to “lever up” — because the people either can’t or won’t.
The consequence of this is not hard to figure out.
If you have 1,000 units of production and 1,000 units of credit or currency with which to buy that production, and you then emit another 1,000 units of credit into the system, the price of something will rise. By bringing this pressure on market prices artificially you will spur people to produce more. This is what all the politicians and monetary wonks claim is a “virtuous cycle”, but they’re wrong, because the demand that led to the increased output is not real.
If this was a one-time shot it might be defensible, but it can’t be due to the fact that the borrowed funds have to be paid back. This in turn leads you to demand $X + 1 in “stimulus” next, because the “+1″ is necessary to cover the carrying costs on your original $X borrowing.
This is the trap into which Japan fell. Now they’re trying to “force” inflation, when the natural economic state is a mild deflation — exactly as they have had!
They can force inflation but in doing so they will destroy the purchasing power of their lower and middle classes, which eventually will lead to the collapse of their society and government.
This is exactly the policy being propounded here in the United States, and in fact the policy being run since 2008. Barack Obama, with the full complicity and in fact cooperation of Congress, including the Republican House, have pursued the mathematically certain bankrupt strategy of deficit spending as a means to “reflate” the economy.
But while the stock market is close to its previous highs real purchasing power of the lower and middle classes, along with the labor force participation rate, is worse today than it was in 1980 and the rate of deterioration is accelerating!
There is no way out of this box without acceptance of the adjustment that must be taken in the economy as a whole, and the longer we continue to play the game of subsidy and handout, which is really nothing more than reaching into one pocket, withdrawing two $20s, putting one into the other pocket while the other on fire and then claiming to be $20 richer, the worse our outcomes in the economy and society will be.
No serious discussion or debate about the budget can take place without the removal of these cross-subsidy effects, and nowhere are they more serious than in the stock market and health care sector. Those two areas, particularly the latter, must be addressed.
But as of right now they’re not even under discussion while we are but one small economic incident away from triggering the next major downturn — with no policy tools remaining to address it.
That incident is coming and is likely to be as simple as market recognition that the driver of asset inflation through the last 30 years is no longer present and cannot be restarted, despite claims to the contrary that it’s “just around the corner.”
When that recognition hits the markets – and it will – look out.