Tag: private non-financial debt

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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

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The path to recovery: how to bring the debt binge under control

The debt binge since 1975, fueled by an easy-money policy from the Fed, has landed the US economy in serious difficulties. Wall Street no doubt lobbied hard for debt expansion, because of the boost to interest margins, with little thought as to their own vulnerability. There can be no justification for debt to expand at a faster rate than GDP — a rising Debt to GDP ratio — as this feeds through into the money supply, causing asset (real estate and stocks) and/or consumer prices to balloon. What we see here is clear evidence of financial mismanagement of the US economy over several decades: the graph of debt to GDP should be a flat line.

US Domestic and Private Non-Financial Debt as Percentage of GDP

The difference between domestic and private (non-financial) debt is public debt, comprising federal, state and municipal borrowings. When we look at aggregate debt below, domestic (non-financial) debt is still rising, albeit at a slower pace than the 8.2 percent average of the previous 5 years (2004 to 2008). Public debt is ballooning in an attempt to mitigate the deflationary effect of a private debt contraction. Clearly this is an unsustainable path.

US Domestic and Private Non-Financial Debt

The economy has grown addicted to debt and any attempt to go “cold turkey” — cutting off further debt expansion — will cause pain. But there are steps that can be taken to alleviate this.

Public Debt and Infrastructure Investment

If private debt contracts, you need to expand public debt — by running a deficit — in order to counteract the deflationary effect of the contraction. The present path expands public debt rapidly in an attempt to not only offset the shrinkage in private debt levels but also to continue the expansion of overall (domestic non-financial) debt levels. This is short-sighted. You can’t borrow your way out of trouble. And encouraging the private sector to take on more debt would be asking for a repeat of the GFC. The private sector needs to deleverage but how can this be done without causing a total economic collapse? The answer lies in government spending.

Treasury cannot afford to borrow more money if this is used to meet normal government expenditure. Public debt as a percentage of GDP would sky-rocket, further destabilizing the economy. If the proceeds are invested in infrastructure projects, however, that earn a market-related return on investment — whether they be high-speed rail, toll roads or bridges, automated port facilities, airport upgrades, national broadband networks or oil pipelines — there are at least four benefits. First is the boost to employment during the construction phase, not only on the project itself but in related industries that supply equipment and materials. Second is the saving in unemployment benefits as employment is lifted. Third, the fiscal balance sheet is strengthened by addition of saleable, income-producing assets, reducing the net public debt. Lastly, and most importantly, GDP is boosted by revenues from the completed project — lowering the public debt to GDP ratio.

Public debt would still rise, and bond market funding in the current climate may not be reliable. But this is the one time that Treasury purchases (QE) by the Fed would not cause inflation. Simply because the inflationary effect of asset purchases are offset by the deflationary effect of private debt contraction. Overall (domestic non-financial) debt levels do not rise, so there is no upward pressure on prices.

Infrastructure investment should not be seen as the silver bullet, that will solve all our problems. Over-investment in infrastructure can produce diminishing marginal returns — as in bridges to nowhere — and government projects are prone to political interference, cost overruns, and mismanagement. But these negatives can be minimized through partnership with the private sector.

Projects should also not be viewed as a short-term, band-aid solution. The private sector has to increase hiring and make substantial capital investment in order to support them. All the good work would be undone if the spigot is shut off prematurely. What is needed is a 10 to 20 year program to revamp the national infrastructure, restore competitiveness and lay the foundation for future growth.

There are no quick fixes. But what the public needs is a clear path to recovery, rather than the current climate of indecision.

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