US public debt growing at unsustainable rate

We often blame Fed monetary policy for the GFC, with interest rates at exceptionally low levels leading to “Greenspan’s bubble.” Treasury was just as culpable, however, with the massive 2004-2005 surge in public debt flooding the market with liquidity. The repeat in 2008-2011 was more justifiable: the spike in public debt was necessary to offset the sharp decline in private (non-financial) debt which would have caused a deflationary spiral. The effect was to smooth out the fall in total domestic debt (public and private) and create a relatively “soft” landing for the economy.

Government, Domestic and Private (Non-Financial) Debt Growth

Quick Glossary

  • Domestic debt is all local debt, both government and private sector
  • Non-financial excludes the financial sector from debt calculations as it largely acts as a conduit for other sectors.
  • Government debt includes federal, state and local government borrowing
  • Private debt is all Domestic debt other than Government. It includes both Corporate and Household debt.
  • Household debt is all debt owed by private households, as opposed to the corporate sector.
  • GDP is the market value of all final (excludes intermediate) goods and services produced within a country in a given year/quarter.
  • Nominal means before adjustment for inflation.

Government and Domestic Debt Growth compared to GDP

Public debt growth is slowing but needs to fall further in order to keep the economy on a sustainable path. A rough rule of thumb is that public debt should grow no faster than GDP — so that it does not outgrow the nation’s ability to repay. With public debt growing at 8.6% and GDP at a nominal rate of 4.1%, Treasury’s ability to repay — and its credit rating — is deteriorating. Reduction of public debt growth to a rate of no higher than 4.1% is necessary. Increases in tax collections as a percentage of GDP would alter this basic equation, but are highly unpopular and act as a disincentive to further GDP growth.

It should be evident from the above chart that GDP contracts when the rate of domestic debt growth slows. If domestic debt ever had to contract (below zero growth), you can imagine the impact that it would have on GDP. That is a debt-deflation spiral and should be avoided at all costs. So, although we would all like to see a sharp reduction in debt levels, there are limitations on how quickly this can be achieved — without smashing the economy into a brick wall.

We can also see that GDP growth for the past decade has been largely debt-fueled. Only recently has GDP growth surged above the growth rate of domestic debt, reflecting an increase in productivity. That is what we (not just the US) have to strive for: to widen the positive gap between GDP and domestic debt growth, while bringing public debt growth below the nominal rate of growth in GDP.

Reducing the rate of growth in public debt will not be easy, however, with private debt growing at a miserly 0.8% compared to domestic debt at 3.0%. The difference is made up by government debt, growing at a whopping 8.6%. Private capital expenditure, however, has in many cases been brought-forward to take advantage of accelerated tax write-offs and is likely to slow in the months ahead. Even worse is household debt which is contracting at an annual rate of 0.9%. So the medium-term outlook for private debt may be near-zero growth. And further slowing of public debt growth would court another recession.

Domestic, Household and Private (Non-Financial) Debt Growth

EconoMonitor » All Feasts Must Come to an End: China’s Debt & Investment Fuelled Growth

Satyajit Das: New lending by Chinese banks in 2009 and 2010 was around 40% of GDP. New bank loans in 2009 and 2010 totalled around $1.1-1.4 trillion, an increase from $740 billion in 2008. Total outstanding loans in the economy have jumped by nearly 50 per cent over the past two years.

Around 90% of this lending was directed towards investment in building, plant, machinery and infrastructure by State Owned Enterprises (“SOE”). In 2010, China allocated over $2.6 trillion to investment expenditure – the highest proportion of GDP of any major economy in the world. According to the World Bank, almost all of China’s growth since 2008 has come from “government influenced expenditure”.

via EconoMonitor : EconoMonitor » All Feasts Must Come to an End: China’s Debt & Investment Fuelled Growth, Part 1.

Steve Keen: Australia & Canada face debt-deflation crisis

http://www.youtube.com/watch?feature=player_embedded&v=f7iK4DHPr9E#!

[23 minutes]

Real Recovery: America’s Debt is on the Decline

[A new report from the McKinsey Global Institute] estimated that home equity loans and cash-out refinancing increased consumer spending by a percentage point to 3 percent growth a year during the housing bubble years. But with that source of debt financing gone, retailers are more likely to see 2 percent annual growth over the next few years, which is about where it has been in recent months.

via Real Recovery: America’s Debt is on the Decline.

Canada’s Household Debt Is Rising – WSJ.com

OTTAWA—Increased household debt in Canada, underpinned by rising house prices and low interest rates, poses a key domestic risk to financial stability, the Bank of Canada said on Thursday.

The finding, contained in the central bank’s quarterly economic review, was the latest in a series of warnings from economists and Canadian officials that high consumer borrowing has emerged as one of the economy’s biggest risks. Household debt stood at over 150% of personal disposable income as of the third quarter of last year, the report noted.

via Canada’s Household Debt Is Rising – WSJ.com.

Greek death spiral accelerates – Telegraph Blogs

Ambrose Evans-Pritchard: This is what a death spiral looks like. It is what can happen if you join a fixed exchange system, then take out very large debts in what amounts to a foreign currency, and then have simultaneous monetary and fiscal contraction imposed upon you.

Germany discovered this on the Gold Standard when it racked up external debt from 1925 to 1929 (owed to American bankers) in much the same way as Greece has done.

When the music stopped – ie. when the Fed raised rates from 1928 onwards – Germany blew apart in much the same way as Greece is blowing apart. This is not a cultural or anthropological issue. It is the mechanical consequence of capital flows into a country that cannot handle it, as Germany could not handle it in the late 1920s.

via Greek death spiral accelerates – Telegraph Blogs.

Australia: Credit growth

Latest stats from the RBA show that the sharp contraction in business credit has slowed, but growth of personal credit (mainly mortgage finance) is at its lowest rate since the early 1990s and is trending downwards. Credit growth does not have to fall below zero for it to have a negative impact on the economy. A fall in the rate of credit expansion will slow the rate of economic growth.

Australian Credit Growth

What’s Going on With Debt in U.S.? – Real Time Economics – WSJ

The chart shows clearly the build up of debt heading into the bust, and the subsequent deleveraging. Overall public and private debt, by this measure, peaked at 302% of GDP in the first quarter of 2009. Since then, it has fallen to 279% as the economy has grown and some private players have lightened their debt loads.

US Debt by Sector as Percentage of GDP

via What’s Going on With Debt in U.S.? – Real Time Economics – WSJ.

Comment: ~ The Financial sector can be ignored as this merely acts as a conduit for, and mirrors, the other sectors. My concern is that Government debt is growing at a faster rate than the fall in Household and Nonfinancial Corporations debt. That is unsustainable and is likely to reverse after the November elections. At which point the economy will contract.

Nouriel Roubini’s Global EconoMonitor » The Straits of America

Given the bearish outlook for US economic growth, the Fed can be expected to engage in another round of quantitative easing. But the Fed also faces political constraints, and will do too little, and move too late, to help the economy significantly. Moreover, a vocal minority on the Fed’s rate-setting Federal Open Market Committee is against further easing. In any case, monetary policy cannot address only liquidity problems – and banks are flush with excess reserves.

Most importantly, the US – and many other advanced economies – remains in the early stages of a deleveraging cycle. A recession caused by too much debt and leverage (first in the private sector, and then on public balance sheets) will require a long period of spending less and saving more. This year will be no different, as public-sector deleveraging has barely started.

via EconoMonitor : Nouriel Roubini’s Global EconoMonitor » The Straits of America.

Westpac: Follow that Flow

  • The US recovery from the 2007–2009 recession has been particularly disappointing, in part due to the moribund state of the housing market.
  • The state of the housing market is in part a symptom of excess leverage, the US’ core concern.
  • Excess leverage will continue to weigh on US economic growth, restricting it to a sub-trend pace for the foreseeable future, resulting in a need for further QE.

….. Given the size of the US’ debt stock and the lack of assets set aside to fund future pension liabilities, it is logical to conclude that above-trend growth conditions are a long way off. In the meantime, households and government authorities will remain heavily exposed to any further deterioration in conditions, whether it be domestic or foreign (i.e. Europe) in origin.

QE3 will be needed merely to help protect against a further deterioration in economic conditions. Such a program would have to be large in scale and in coverage, likely covering USTs, mortgage securities and, with time, the existing debt of SLGs.

A final point: the degree of easing required to alleviate the financial stresses the US economy currently faces (and hopefully at least maintain the current level of activity) has not been recognised by markets. Given the precarious state of Europe, the market will likely take its time in coming to terms with the US’ own concerns. But, when the spotlight falls on the US, we expect a greater awareness of US credit risk and the absence of near-term growth prospects will see yields rise and the US dollar fall.