Despite the Thatcher and Reagan revolutions…deficits still matter.
Consumer debt came into the world as a simple act of kindness:
“Don’t worry, Mrs. McMurphy, you can pay me next week.”
But consumer debt grew up and grew mean. As mentioned in this column previously, until 1980, total credit market debt in America never exceeded 130% of GDP. Now, it is more than 330%. (What happened in 1980? Ah, more about that below…) And derivative contracts, based on credit, have grown even faster. There are now $45 trillion worth of credit default swaps, for example, up nine-fold in the past three years.
So heavy is the burden of this consumer debt that householders at the bottom of the financial pyramid are being crushed like Egyptian slaves. “Mortgage Meltdown,” is easily the most popular headline in the U.S. financial press. Under its banner, the Chicago Sun-Times reports that there is about one house in foreclosure on every block of the Windy City. What’s astonishing is that well-heeled areas are affected too – with foreclosures running 100% ahead of last year in one middle class neighborhood…and up 193% in an area thought to be ‘wealthy.’
What has happened? Credit, it turns out, soon reaches the point of diminishing returns. During the entire period up until 1980, it took about $1.40 worth of extra credit to produce a single extra dollar of GDP. Since then, the ratio has deteriorated…with recent figures showing as much as $7 in new credit per additional buck of output.
And now…we seem to have passed the top of the credit cycle – with the credit industry unwilling to pony up more cash…and output falling. John Crudele, perhaps jumping the gun, says the U.S. economy may already be in recession.
Who is the culprit? You could blame central bankers…or the City…or Gordon Brown and George W. Bush. Or, you could blame the entire human race.
Man cannot leave well enough alone, we conclude. He gets ahold of an idea and he cannot help himself. He takes it up clumsily, as he would a new wrench. Then he begins twisting it…hammering it…stretching it out…sharpening it…until he can use it to cut his own throat.
Every innovation turns against him. His television brings him reality shows. His automobiles lead him into traffic jams. And scarcely a single generation after he invented them, his airplanes are dropping bombs on London.
These consumer debt mushrooms were no exception. They grew in a hothouse – nurtured by extraordinary popular delusions…fertilized by the rich manure of politics…and abundantly watered by liquidity from central banks. People ate them; their debts grew as large as their hallucinations.
Forget about the central banks; their role is so obvious. But think about the New Era that came in the 1980s – thanks to the revolutions wrought by Mrs. Thatcher and Mr. Reagan. They brought in a fresh idea – that capitalism could be unleashed…and that it would serve man as obediently as a cocker spaniel. We don’t dispute that there was some truth in it. But it wasn’t quite as true as people came to believe. Especially in its grotesque new form.
Where in capitalism is the idea that you can spend more than you earn? Where in the vision of Adam Smith is the idea that foreigners will subsidize your standard of living – indefinitely? Where in laissez-faire is the notion that central bankers will prevent corrections by controlling the price of money? What had happened to the old sturm and drang? Where was Schumpeter’s ‘creative destructive?’ The new capitalists offered creation without destruction… resurrection without crucifixion! They offered not only to hold harmless investors in the face of their own bad judgment…but to revive booms before they ever expired and to cut short corrections before anything has been corrected.
This was not the old capitalism of our grandfathers. The old-timers had been wary of it…they knew that the free market was dangerous and unpredictable. The old capitalism was a jungle…red in tooth and claw. You had to watch your back. This new capitalism was a zoo; all the dangerous beasts were supposed to be behind bars. It was almost too wonderful.
The culture of zoo-capitalism spread to all levels of society. At the top, such was faith in this new doctrine that tax rates were reduced…in the belief that more capitalism would enlarge the tax base (unfortunately, spending increased faster). But don’t worry, “Deficits don’t matter,” said Dick Cheney. In other words, our dynamic capitalistic economy will grow itself out of any problems. And at the bottom, too, people fell victim to the same delusion. Consumer debt multiplied as householders borrowed and spent money they hadn’t made yet. Why not? Their houses, their stocks and their incomes would always go up, wouldn’t they? And savings? Who needs savings when you live in the strongest, most flexible, most globalized, most technology-enhanced, most tax-enlightened economy in history?
That is the trouble with man. First, he does. Then he overdoes. His progress takes him backwards. Every blessing evolves into a curse…and every revolution leaves him mounting the scaffold.
Markets and Money