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Debt Man Walking
Perspective on the News
Friday, August 05, 2011
Ed DeShields

The last six decades ought to tell us all we need to know about the issues America now faces with its debt crisis.  Our government will hash out an agreement on the debt limit and tuck it away hoping we won’t have to discuss it again until later.

It is irrelevant which side you’re on in the political debate.  Neither plan will work so it’s going to be all about what the outcome will look like.

We’ve now extended the nation’s credit line and, in exchange, promised to cut spending by a similar amount beginning is 2014.  Thus, we’ve borrowed more and promised to pay it back by cutting our budget a little each year over a ten year period.   Sounds nice and tidy.

We’ll never actually pay it back though.  Our debt will continue to grow each year reaching about $20 trillion by 2020.   If you add off-balance sheet debt, the total liability of our nation reaches about $75 trillion (just about the size of the entire world’s total output in goods and services).   You could characterize this as, “all the money in the world” so-to-speak.

What we are learning the hard way is that there is probably not a palatable policy solution to correct our balance sheet as our financial position pushes us into a gradual shrinking of our nation’s output.

So what’s the outcome likely to look like?

First, the problem is different this time.  This is a problem of our debt being so large it is unlikely our politicians alone will be able to correct the problem.

My good friend, and private wealth fund manager, John Schmit puts it this way,

“it is the elephant in the kitchen.  As long as the elephant remains the refrigerator is off-limits and you risk getting squashed if you need something to eat.” 

What Schmit means is that our debt problem originated from having too much credit over the last 60 years.

Here is some potent evidence.

Say, your credit card company kept raising your credit limit faster than your ability to pay it back.  The more you spent the more impossible it became to make your minimum payment.  Eventually you would realize that your spending must be cut back or your credit card company was going to do it for you.  Since you need that credit card to live, you get real concerned about your relationship with credit.  That’s where our government is today.

Using Schmit’s analogy, the elephant in the kitchen is now so large it’s starting to keep us from getting to the refrigerator.  And now, we’re going to go on a crash diet – whether we like it or not!

This is not to say there is no solution. There is and it is called debt restructuring (a nice term for default).  Schmit says,

“But this is voodoo in the world of 21st century politics. Restructuring debt is a formula for getting voted out of office.  But debt is apolitical. It doesn’t care whether the decision maker is Democrat or Republican, German, Greek or Japanese.  The debt is in control. We know this. It could not be clearer.”

Now to the hardcore reality.  We’re going to have to reduce our borrowing by over $7 trillion just to get to the nose bleed peak of the 1930s.  What Congress just did was increase it.   Consequently, we’re headed in the wrong, desperate, direction.

Getting to a healthy long-term baseline requires eliminating over $20 trillion of our available credit.  The political talking points were right in this debate as some said, “This money we need isn’t for new spending.  It’s money we’re already legislated to spend!”   These words were actually spoken as if this made this the concept justifiable.

In a recent report, Schmit took a look back 60 years.  Starting December 1950 our nation’s private debt was $120 billion.  Today it is $14 TRILLION, a 7.4% compound growth rate.  Keep in mind that real GDP only grew 3.3% over this period.  Not to be outdone, our Federal debt grew at 6.9% over the period so it too out-paced GDP growth.

Not only is the spread of debt growth over GDP growth very large, it has been going on for 60 years.  When credit growth outpaces GDP growth for a sustained period there will be an eventual reckoning.   You can bet on it.

How stupid were we to let the credit bubble get this big?  Six decades of mismanagement is inexcusable.  Isn’t it?  So this problem is neither a Bush nor Obama issue.  The debt grew during the Clinton years too.  The next time you hear a politician blame another, that’s our cue to fire them.  They’re lying or they’re incompetent.

Remember that 70% of the U.S. economy is consumption. If this ratio continues to decline growth will be anemic or negative.  This is exactly what we’re seeing with the revised GDP forecasts this week and is right on target from my previous forecast of events.

That elephant has blocked the path to the refrigerator.

We’re going to have to reduce our credit line, not increase it to get back to a healthy baseline.  Getting back to the 1981 baseline requires $3.5 trillion in future reduced credit or about 25% of total GDP.

Let me ask you.  What’s that going to do to employment when the capital supporting 25% of our economy goes on a diet?  Yep, it’s going to kill it.

This is why the Congress is in a quandary.  The only viable solution is restructuring (the D-word; default).  The longer we wait to restructure with extend and pretend policies the harder the landing and the bigger the cost.

To this point the Tea Party has it right.  Despite their bedside manner, they’re going to get us back to the 1981 baseline, regardless of the pain.  That’s why all the politicians, on both sides of the aisle, will be thrown out of Congress before this is over.

The fact that the credit expansion outpaced GDP growth for over 60 years without stopping is frankly amazing.

Just for the record, there’s one final solution to consider.  There are many who would suggest a debasing of the currency is necessary to make these adjustments.   And, as I’ve said before this is what will happen – perhaps as early as this year.

We have now reached the end of our ability to fund GDP stability at a time when we have just begun to deleverage the economy.  There just may not be a policy remedy for this problem.  And to those who say it is not the end of the world, I say true.  But, when the world wakes up to this concept there is likely to be significant transfer of wealth to those that are prepared for it and a lot of others who will be starved of the lifestyle they currently enjoy.

About Ed DeShields

Last article:  Mr. President don't let the Truth Spoil a Good Story

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