The Big Q: Is Debt Good or Bad?
The Big A: Yes & Yes
Debt is future spending driven forward in time. It lets you buy something now for which you do not have the cash “yet”.
Whether it is smart or not depends on what one buys.
Many people, businesses, and governments borrow because they can. That has been possible for the past 10 years because central banks made cheap.
It was the thing to do then, remember?
But now it is less so,as the central banks start to tighten.
Earlier this year, John Mauldin wrote a series of articles predicting a debt “train wreck” and eventual liquidation. John dubbed it “The Great Reset”. He estimated then that in another year or 2 the debt crisis will becomes fully evident.
Now he is having second thoughts, as he sees events that signal the reckoning could be closer than he envisioned earlier this year.
The Big Q2: Why is that?
The Big A2: Central banks enable debt because they think it will generate economic growth, and it does, sometimes.
The problem is they create debt with little regard for how it will be used. That’s how artificial booms and subsequent busts happen
Consumers and politicians are told not to worry about absolute debt levels so long as the economy is growing in line with them. That makes sense, Yes?
A country with a larger GDP can carry more debt. But that is not what is happening.
Below are Key data points that shows debt is losing its ability to stimulate growth.
- In Y 2017, $1.00 of non-financial debt generated only 40c of GDP in the US, and less elsewhere, down from more than $4.00 of growth for each $1.00 of debt 50 years ago.
- China’s debt productivity dropped 42.9% between Y 2007 and 2017. That was the worst among major economies, but others lost ground, too.
- Now all the developed world is pushing the same string and it is wrinkling up
So, when debt if used to stimulate growth, and debt loses its capacity to do so, the powers-that-be add more debt.
John calls this classic addiction behavior. Meaning 1 has to keep raising the dose to get the same high.
But, history show us that every prior debt run-up eventually took its toll on the economy, because there is always a Day of Reckoning, or the Day the Chickens come home to Roost.
Today, the US economy is so huge and powerful that its current $24.5-T government debt could easily grow to $40-T before we meet that Day of Reckoning.
The US is just a recession away from having a total $30-T US government debt. It will happen and deficits will stay well above $1-T per year every year after that, as it is doing now.
The US budget deficit is under $800-B this year, but it added over $1-T of actual debt due to so-called off budget items that the US Congress thinks should not be part of the budgetary process. In those items are Social Security and Medicare, and can be anywhere from $200 to 500-B annually.
The US Treasury borrows those dollars and it goes on the total debt taxpayers owe. So, the true deficit that adds to the debt is actually much higher than the number you on that meter we see on the financial news.
Household and corporate debt is growing fast and not only in the US.
Here is a note from Economic Cycle Research Institute’s Lakshman Achuthan: “Notably, the combined debt of the US, Eurozone, Japan, and China has increased more than ten times as much as their combined GDP over the past year.”
In the last year, the world’s largest economies are generating debt 10X faster than economic growth. Adding debt at that pace, if it continues, will boost the debt-to-GDP ratio at an alarming rate.
Mr. Lakshman continues: Remarkably, then, the global economy—slowing in sync despite soaring debt—finds itself in a situation reminiscent of the Red Queen Effect we referenced 15 years ago, when tax cuts boosted the US budget deficit much more than GDP. As the Red Queen says to Alice in Lewis Carroll’s Through the Looking Glass, “Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!”
Let’s try to imagine a scenario where this ends in something less than chaos and crisis, and the best is a 10 years of stagnation while the debt gets liquidated.
John Mauldin notes: “But realistically, that will happen because debtors will let it. And they outnumber lenders. For this reason, something like “the Great Reset” will happen first.”
The rational course would be to delay the inevitable as long as possible, yet in the US we seem to rushing into it.