The US appetite for debt keeps growing(Read article summary)
While the private sector is de-leveraging, the public sector is borrowing and spending more than ever.
We went around the world last week. We wish we could say we learned something. But modern travel has been standardizedâŚand culture and technology have been âglobalizedââŚso that the more you travel the more you feel you never left home.
âHow was your trip around the world?â asked our assistant when we got back in the office in Baltimore.
âNo problem. Nothing special,â we replied.
How could a trip around the world not be âspecialâ? Well, the airports all look alike. The planes are all alike. The restaurants and hotels are all alike, usually international chains. So are the shopsâŚand the products.
You can travel to the far side of the globeâŚand except for the fact that you canât quite remember where you areâŚor what time it isâŚyou might as well have stayed putâŚ
Returning to the USâŚ
We got the big news when we picked up a copy of USA Today in the LA airport.
âLight at the end of the debt tunnel?â asked the headline.
We thought we knew the answer before we started reading.
But the report in USA Today tells the results of a study by McKinsey Global Institute. As a percentage of GDP, the US cut its âprivate and public debtâ by 16 points, since 2008, it says. That puts it tied with South Korea in the debt-cutting derby.
We were only a paragraph into this report when we began to suspect that neither the reporter nor the McKinsey researchers had any idea what was going on.
Sixteen percentage points is not bad. But, as we recall, total debt in the US was around 325% of GDP. Take off 16 pointsâŚitâs only a 5% reduction. Besides, US government debt alone INCREASED during this period. The feds are the largest debtors in the world. And they added 66% to their debt over the last three years. It was $9 trillion in â08. Now itâs $15 trillion. An addition of $6 trillion.
The dots given in the USA Today report donât connect with the dots we know. It maintains that total debt in the US was 279% of GDP in the second quarter of last year. And it says financial debt fell by less than $2 trillion and household debt by half a trillion. Huh? That doesnât sound like $6 trillion.
We found a better report in The Financial Times. Gillian Tett explains that while the private sector is de-leveraging, the public sector is borrowing and spending more than ever. She goes on to take issue with McKinseyâs âlight at the end of the tunnelâ conclusion.
Yes, the private sector is de-leveraging â just as youâd expect. Most of the debt that is being eliminated is mortgage debt and most of it is eliminated by default and foreclosure. At this rate, McKinsey reasons, US consumers âcould reach sustainable debt levels in two years or more.â
Hallelujah! We just have to wait until 2014 for a recovery.
But wait a minute. McKinseyâs conclusion was based on the experiences of two Scandinavian countries, Finland and Sweden, in the 1990s. The two countries spent too much. Then, they had to cut back. The private sector went into a slump and the public sector took up the slack. When, after a few years, the private sector had reduced its debt sufficiently, it could resume its former growthâŚwhile the government gradually paid down its debts. All was well that ended well. The researchers on the project argue that âtoday the United States most closely follows this debt-reduction path.â
We donât think so. We think the US is on a very different path. Finland and Sweden could pull off this ârescueâ because conditions were completely different.
First, they have smallish populations with much social and political cohesion.
Second, they were able to get back on the growth path because there was a boom going on almost everywhere else; they exported their way back to financial health.
Third, they didnât have that much debt in the first place. The Finns and Swedes could add debt without pushing themselves beyond the point of no return.
Not so the USâŚon all points. America has too much debt. It has no plausible path to recovery. And the feds are adding more debt than it can pay off.
You can do the math yourself, dear reader. With government debt-to-GDP at 100%âŚand risingâŚand the shift to short-term financing over the last few yearsâŚthe feds are extremely vulnerable to an increase in interest rates. A chart in Sylla and Homerâs âA History of Interest Ratesâ suggests that investors want a real rate of return from government bonds in the 3% to 5% range. Thatâs what theyâve been getting, according to the chart, all the way back to 1850.
The current CPI-measured rate of inflation is about 2%. This suggests that nominal bond yields should be in the 5% to 7% range. But at 5% interest, the feds would have to pay out about $750 billion in annual interest charges, which is between a third and a quarter of all expected US tax revenues. Itâs the equivalent of the military budget, for example.
At 5% interest, bond investors would probably be wondering how the feds could stay in business. Most likely, yields would spiral out of control quicklyâŚforcing the feds to print more money to cover deficits. In a matter of days, the whole jig would be up.
Which is what makes the other big news so puzzling.
âNegative yield fails to deter investor appetite for Tips,â said one headline.
â30-year US loan rate hits nadir,â said another.
What both headlines are telling us is that either weâre wrong about how the world worksâŚor the world isnât working quite as well as it should be. The second explanation suits us best. The public sector is leveraging up. It is going deeper and deeper into debt. As it adds to the quantity of its debt outstanding, the quality should go down. And the price too. But itâs not. So, either the times are out of jointâŚor we are.
For now, the weaker US finances get, the more people seem to want to lend it money.
This has to end badlyâŚ
Â for The Daily Reckoning