We got the big news when we picked up a copy of USA Today in the LA airport.
“Light at the end of the debt tunnel?” 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 “private and public debt” 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 points…it’s 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 ’08. Now it’s $15 trillion. An addition of $6 trillion.
The dots given in the USA Today report don’t 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 doesn’t 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 McKinsey’s “light at the end of the tunnel” conclusion.
Yes, the private sector is de-leveraging – just as you’d 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 “could reach sustainable debt levels in two years or more.”
Hallelujah! We just have to wait until 2014 for a recovery.
But wait a minute. McKinsey’s 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 growth…while the government gradually paid down its debts. All was well that ended well. The researchers on the project argue that “today the United States most closely follows this debt-reduction path.”
We don’t think so. We think the US is on a very different path. Finland and Sweden could pull off this ‘rescue’ 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 didn’t 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 US…on 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%…and rising…and the shift to short-term financing over the last few years…the feds are extremely vulnerable to an increase in interest rates. A chart in Sylla and Homer’s “A History of Interest Rates” suggests that investors want a real rate of return from government bonds in the 3% to 5% range. That’s what they’ve 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. It’s 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 quickly…forcing 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.
“Negative yield fails to deter investor appetite for Tips,” said one headline.
“30-year US loan rate hits nadir,” said another.
What both headlines are telling us is that either we’re wrong about how the world works…or the world isn’t 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 it’s not. So, either the times are out of joint…or we are.
For now, the weaker US finances get, the more people seem to want to lend it money.
This has to end badly…
for Markets and Money