Over the last 48 hours, I have read or heard the phrase “double-dip recession” no fewer than four times. In each instance, the phrase was used via a major media outlet. Robert Reich said point-blank “we’re falling into a double-dip recession.” CNN repeated the phrase. British PM Cameron said yesterday that Britain’s peacetime record budget deficit could anchor us for decades. Fed Chairman Bernanke used the phrase yesterday in a speech, as a foil. The meme is spreading.

Since the economic meltdown of 4Q08 (and subsequent bailout) I have been skeptical of a theory that seeks to build prosperity on a foundation of massive debt and worthless paper. Is Reich right? Does this growing loss of confidence portend a downturn? I want to briefly explore what are arguably the three key markers of economic health.

1. Employment

As a former Secretary of Labor, Reich makes his central point: “the labor market continues to deteriorate… the median wage continues to drop.” He argues, and I would tend to agree, that we have artificially prolonged an inevitable reckoning by (1) increasing liquidity via massive debt, (2) coaxing a temporary boost with near-zero interest rates (which cannot be sustained), and (3) deferring replacement of aging hard goods (cars, capital, etc.). Of course, Reich has the solution:  raise taxes so government can fix it with more redistribution programs (!) An outrageous contradiction.

2. Real Estate

Interest rates are at near-historical lows, yet new mortgages are at a 13-year low. IMF economists are predicting a dramatic continued downturn in real estate values – in some markets as much as 40%. The taxpayer-funded housing credit has expired, there are over 1 million bank-owned homes not yet on market, another 5 million mortgages are expected to end in foreclosure, another 6.3 million homes sit vacant (not to mention a growing amount of distressed commercial property), April year-over-year real estate values are down 4.1%, and interest rates cannot remain at record lows much longer. According to WSJ, post-tax-credit home activity (May) is down 25-30% – a trend they say will continue.

3. Debt Ratios & Unfunded Liabilities

U.S. national debt has just surpassed 90% of GDP ($13 trillion – adding $1 million every 30 seconds) – a peacetime record. Click on the link and compare the external Debt-to-GDP ratios of USA and China (hint: it’s 94% vs. 8%). Total U.S. unfunded liabilities are $109 trillion, and growing without any sign of turning back. This is nearly twice the GDP of the entire world ($58 trillion). And with an aging population, the growth of these unfunded liabilities (medicare, social security, etc.) are showing no sign of slowing. They are, in fact, accelerating.

We lifted ourselves out of a wartime debt (125% of GDP) because our 1940’s economy was roughly 60% primary productivity (industrial, agricultural, manufacturing). Today, 80% of U.S. GDP is based on secondary activity (services, tax funded, etc.). The economic engine has shifted to the Far East, which holds dramatically increasing amounts of U.S. debt.

We have a serious and worsening Debt-to-GDP problem. I would call it a National Emergency. The Federal Government is not the solution. It is, to a large extent, the problem.

We are moving steadily away from producing what we need in this country. We are also moving away from producing on a scale that enables us to trade for what we do need. Rather than do without, we are increasingly importing things with a promise to pay later. This cannot go on. When our trading partners, especially China, no longer want to loan us hundreds of billions of dollars a year to be paid later, we will have little productive capacity left and we will be a poor nation. We need successful industries and we need to innovate within them to keep them thriving. However, when your trading partner is thinking about GDP rather than profit, and has adopted mercantilist tactics, subsidizing industries, and mispricing its currency, while loaning you the money to buy the underpriced goods, this may simply not be possible. – Ralph Gomory, President Emeritus at Alfred P. Sloan Foundation; Former Head R&D IBM; Research Professor at NYU

With a nod to King Crimson, I repeat myself when under stress:  we can’t build (let alone sustain) a free, buoyant society on a foundation of massive debt. When seen in the light of increasingly scarce natural resources, the U.S. is heading for a national train wreck, effectively becoming a debt slave to a new world financial order.

From the New York Times,

It was too much debt that caused the problem in the first place: a new report by the International Monetary Fund warns that “high levels of public indebtedness could weigh on economic growth for years.”

The world’s budget deficit as a percentage of gross domestic product now stands at 6 percent, up from just 0.3 percent before the financial crisis. If public debt is not lowered back to pre-crisis levels, the I.M.F. report said, growth in advanced economies could decline by half a percentage point annually.

Furthermore, financial policy makers find themselves running out of weapons in their arsenal.

After borrowing trillions to stimulate their economies and ease credit concerns during the last wave of fear in late 2008 and early 2009, governments cannot borrow trillions more without risking higher inflation and shoving aside other borrowers like individuals and companies. Short-term interest rates, already near zero in the United States, cannot be lowered any further. And vital steps like raising taxes or cutting spending increases could snuff out the beginnings of a recovery in northern Europe and worsen the pain in recession-battered economies like Spain, where unemployment recently passed 20 percent.

With the exception of wartime, the public finances in the majority of advanced industrial countries are in a worse state today than at any time since the industrial revolution.

A little group called Consumer Metrics Institute has been remarkably accurate at predicting economic trends roughly six months before they happen, including the 2008 crash. As their model predicted, 2010 U.S. GDP has been growing at a 3% annual rate. But CMI now predicts a 3Q drop into 2% contraction. At best, they call for an “extended mild slowdown” in the recovery — at worst they are predicting the early stages of a deep, prolonged structural economic shift, also known as a double-dip recession.



3 thoughts on “Debt

  1. Hi John,

    Thanks for putting these challenges in front of us. Till it’s realistic that someone can get elected while confronting the crisis head on, we’re stuck with bad faith political dialog. Very sad, but perhaps a growing sense of the need to do something is in the air. For what it’s worth, here are a few things we (USA) could do, if there were a collective will:

    Raise Medicare, Soc. Sec. to 75 years for full benefits. (I’m close enough to retirement now that I can note that without passing the buck…)

    Stimulate a non-consumer economic sector by creating standards for expertise in many different areas–from the arts and trades to technology and the humanities–and allow the free market to compete with traditional educational providers. This could transform how we think of the good life.

    Experiment with transforming society by identifying economic sectors that we want to grow–alternative energy is the obvious one–picking cities that need a boost, and use dollars that would go to unemployment to help fund the enterprise.

    Many more could be added–the point being that we lack hope because we lack the courage to confront the crisis, not because there are no ways forward.

  2. Tracy, we were just visiting grandma. Her friend is 72, and still working full-time. I personally have no plans to “retire” for I love what I do. Perhaps there is no alternative to raising the s/s age – how else can we cover the growing senior population forty years out?

    I have hope, but not in governments. I think we’re approaching a train wreck between free-markets and socialization: there’s only so much real wealth (energy) go around. I remain an advocate of creative, innovative, incentive-rich free markets, coupled with deep reforms that (1) limit corporate influence on lawmakers (lobbying and revolving door reform), (2) limit government intervention in free-markets (e.g., enabling home loans to obvious credit risks), (3) regulate far stricter controls and limits on free-market debt / leverage (derivatives, etc.), (4) mandate limits to government spending and debt creation, (5) reduce the size and cost of military with greater emphasis on reserves, and (6) radically simplify the tax code (this alone could both raise revenues while saving us >$300B annually in wasted overhead). Please spend 5 minutes with this revealing video.

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