Karl Denninger makes a simple but telling point. Since 1984 GDP growth has averaged 4% per year, debt growth has averaged 7% per year and government spending growth has also averaged 7% per year. In no quarter did real economic growth exceed credit growth. Europe Goes Enron (blog radio podcast). Simply put, we are inflating credit faster than we are raising real economic output. To repay debt, sufficient income must be generated to reduce this debt. Thus, when the economy lags in a recession or depression, debt will go into default and must be either written off or restructured.
Also simply put, credit growth unsupported by income growth has distorted the economy. In essence, the “easy money” fostered in a lax credit environment has sent the wrong signals to the real economy. Some examples:
Real Estate
Lax bank lending and governmental programs encouraged homeowners to take on more debt. The mantra was that house prices always rose. So bankers were eager to lend too much and borrowers were anxious to borrow too much, both believing that house price inflation would sustain the process. Both parties ignored simple economic principles. Incomes have been stagnating for more than ten years. The housing boom expanded the supply of housing beyond demand. Worse, the peripheral costs of owning a home (taxes, insurance, utilities and the like) ate into the income available to service those over-sized mortgages. Loans were secured with little or no money down.
In the commercial real estate market, we massively overbuilt. Again we mistakenly believed that inflation would bail out lenders and owners. The demographic trend is for large companies to reduce use of commercial space. Increasingly, employees work from home and technology requires fewer workers and less commercial space. Internet shopping further lessens the need for brick and mortar retailers. As with homes, the peripheral costs of commercial ownership kept rising.
Government
A falsely expanding, credit driven economy also sends false signals to government and their employees. Tax receipts were on the rise from real estate transfer fees, expanding income taxes and capital gains from a rising stock market. But these gains were bogus, a chimera. And they did not benefit the average consumer. Why shouldn’t the largesse of rising tax receipts be shared with employees, who also happen to be a powerful voting bloc? Politicians were all too willing to grant pay increases, job security guarantees and costly pension and post-retirement benefits to government employees, especially those represented by powerful public unions. Soon total compensation packages for public employees exceeded their private sector counterparts.
Sovereign Debt
And so the good times seemed to roll. What better way to finance government projects and even foreign wars than through inexpensive sovereign debt? Dick Cheney once loudly proclaimed that “deficits don’t matter.” Republicans and Democrats seemed to compete to see which party could run the largest deficits. Believing that debt could be paid off through ever rising tax receipts, the government made more promises (like expanding Medicare coverage to include prescription drugs). What were they thinking? Borrow today and worry about repaying and credit collapse tomorrow?
Macro Trends
The credit binge occurred against a background of unfavorable macro economic trends. First, US and European population growth, and therefore the supply of workers, slowed. Second, free trade and free movement of capital and technology has exposed the American worker to foreign competition. Seventy-dollar an hour (fully-loaded cost) Big Three unionized auto workers cannot compete with their Asian counterparts. [Heritage Foundation study]. Third, technology has viciously cut into employment in the retailing, telecommunications, banking, insurance, travel and other industries. Software programs now perform the job functions formerly executed by highly-paid skilled workers. Fourth, zero interest policy has cut the income of savers and pension funds, impoverishing a class of consumers who supported the economy in the past. Fifth, regulation is on the rise, increasing business operating costs.
The Debt Bubble
Thus, we have inflated a giant credit bubble without the resources to repay these debts. It is happening both here and in Europe. Each government maneuver to save a bank (Bank of America) or a country (Greece) is merely an attempt to hide the real problem or shift it from private parties to taxpayers. We undertook debt that we cannot repay. We need to write off or restructure this debt, and yes, it will result in losses to the government and major financial institutions. Restructuring could take the form of increasing the time to repay, reducing the interest rate or swapping equity for debt. This outcome is unfortunately unpleasant but necessary.
Governments continue to conjure exotic, “cutting edge,” “outside the box” programs which merely delay the day of debt reckoning. We borrowed too much and we now need to pay the piper.
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