Monday, November 04, 2013

One Word: Debt

Be it their homes or their government,  Americans are running out of time to deal with debt and thus risking a sudden crisis.  If ‘Debt Is Slavery’, then in our homes and legislatures Americans are giving up liberty of action and soon will be at the mercy of events rather than in control.

Former Vice President Dick Cheney was roundly mocked for his claim that ‘deficits don’t matter’.   But he later found support in President Obama, who tells us the deficit is a small issue.   Such bi-partisanship is normally reserved for issues such as drone strikes, kill lists, domestic spying.  So when these two men stand shoulder-to-shoulder on debts and deficits it should generate unease.
Government debt transfers wealth from people living in the future to people living in the present. Politically this works because future people don't vote in current elections.  Thus politicians wave away debt concerns by asserting we will ‘grow our way out of it’.  But we can only grow our way out of it if we actually grow. When debt is a drag upon the economy then we don’t grow. And if we don’t grow, the crisis is inevitable.
Federal debt exceeds $17 Trillion, over 100% of GDP, a level not experienced since WWII.  It appears the official strategy to deal with this overhang is “Default By Inflation”, printing endless dollars and paying back debt with increasingly worthless currency.  However, inflation is toxic to the economy. Think America in the 1970s.

Another solution is one put forth by those such as international investment expert Doug Casey who recommends the government default “in an honest way” by paying current debt holders less than promised which he sees as preferable to, “saddling the next two generations with indentured servitude.”  Bond holders will howl, but Casey  wonders, “how a creditor can cry foul when the government to which he is lending has implicitly said that the value of the money he lent will shrink?”

This debt also has more than just economic effects, but national security implications as well. Because more than half the federal debt is held by foreigners, other countries are gaining increased leverage over American politics and the US economy. 

In his book on the financial crisis, Too Big To Fail, Andrew Ross Sorkin details a disturbing moment from the summer of 2008 when Russia made a high level approach to China proposing they jointly dump their US debt holdings, resulting in a even bigger collapse of the US economy.  This Russian proposal coincided with their launch of war upon Georgia, an American ally. While China declined Moscow’s offer the after effects did resonate in Washington.  In his memoirs, Treasury Secretary Hank Paulson admitted astonishment that the Russians were doing a lot of strategic thinking about US debt.

Debt holders have power over debtors.  In 1956 President Eisenhower sought to block the British from occupying Suez he didn’t need Marines. Instead Eisenhower merely threatened to dump the vast American holdings of British debt thus collapsing the English economy. In that case, a bond was more effective than a bullet.

Debt can beneficial when used to invest, but ultimately a country only gets richer is when production exceeds consumption.  In the past 40 years American households have been consuming more than they produce, hence creating trade imbalances and massive private debt.

 In 1970, US household debt was 40% of GDP and the national savings rate hovered around 10%.  Over the next four decades household debt exploded to 100% of GDP while the savings rate plunged to 1%.  Thus we have replaced vaults of wealth with bags of debt.  The credit reporting agency TransUnion reports 46% of all Americans carry a credit card balance from month to month.  Nearly 40% of new car loans in 2012 were made to those with credit scores below 619, by definition sub-prime.  Then there is the other major sub-prime  calamity, student loan debt, which now exceeds $1Trillion.  The net result of all this baggage is a society driven by the never ending need to finance personal debt and hence leaving Americans economically enslaved.

Debt plagues both the public and private sphere, but the solutions are what they’ve always been: earn more or spend less. Unfortunately family incomes remain stagnant, so households must tighten their belts.  In addition, with no growth in personal incomes there is no growth in income tax receipts. Thus we must resist any economic fear mongering and demand a real shrinkage in the size and expense of government.  We can chose austerity today, or have it forced upon us tomorrow.

In our home and our legislatures debt constrains our options. We can choose to pay now or try to pay later. But the longer we wait the steeper the bill.  Any solution will bring pain, but that is a good thing.  Being a debtor should hurt.  In the direction we’re headed, it’s going to hurt a lot.