All Fed up on Peak Debt

by David Haggith, The Great Recession Blog:

How inflated with debt have we become? How long can we float on our own bloat? Reasonably trim in 1970, the sum of all debt publicly financed by the US government was $275 billion. Last week, the government sought to raise $258 billion in just one week! The weekly financing to keep the government afloat is now about equal to all the debt it amassed over the course of its first 188 years.

We are Fed up on debt

What went wrong? Well, the very next year, President Richard Milhous Nixon took us the rest of the way off the gold standard, allowing the nation’s central bank to create money at will, cutting the tether that had long restrained the Federal Reserve from going insane with using its powers to enrich its member banks. Since the central bank’s customary way of creating new money in the economy is through the issuance of debt by its member banks, we have seen a huge expansion of debt. Whenever the economy is lagging, the Federal Reserve suppresses the market rate of interest to entice people who don’t want additional debt to take more on so they can juice the economy with more spending.

Some people might try to argue that the much lower debt in 1970 is just a matter of inflation. They’d be partway right and all the way missing the point. In today’s dollars, the debt back then would have been $1.2 trillion — still only one twentieth what it is today. But the point they’d be missing is that the inflation they are using to make 1970’s $275 billion debt sound a lot bigger is nearly all due to Nixon removing the central bank’s tether to gold. So, it is a circular path out of the equation.

While the value of the dollar got ground to dust after Richard Milstone Nixon, total debt (now at $67 trillion of public and private debt), even adjusted for inflation, has risen from 150% of GDP to 350%! Over that same time, the Fed’s balance sheet (money in the economy) has grown at about five times the rate of inflation. (General prices have not inflated nearly as much as the supply of money inflated because most of the money circulated in stocks and bonds, creating inflation in those markets. Money only inflated prices where money flows.) Back in 1970, the Fed’s balance sheet stood at $55 billion compared to today’s $4+ trillion.

You don’t have to take my word for these figures. Take it from the Fed. Here’s total public and private debt in the US over GDP:

Think maybe we’ve gotten ahead of ourselves in debt? This increasing rate-of-rise in debt was made possible only by lowering rates of interest and loosening terms of credit. Now the Fed wants to tighten up on that, but there is no way to crush back down on the blue line without compressing the desirable orange line even lower.

Due to the Law of Diminishing Returns, the Fed’s path (and government’s) of increasing GDP by creating money out of debt is now requiring greater amounts of debt to maintain essentially the same rate of growth in total production. You cannot remove the lift created from ever-cheaper credit and not see the orange line fall off when it is that cheap credit that helped it rise.

Of course, the government has decided to come to the rescue by replacing the Fed’s creation of money with its own freeing-up of money that was already there but was taxed away from people; but it’s going to do this through the creation of more debt, too. It thinks. But, with the Fed not buying, who is going to? People who are already over-extended? Investment banks who are no longer getting free money from the Fed intended for buying bonds? People form other countries that are also planning to back off on money creation?

Fiscal conservativism died from morbid obesity!

We have now hit a new norm of $1 trillion annual government deficits in the US (and that only includes on-budget items, which usually don’t include war expenditures, Social Security, etc.). The Republicans, who pretended to be deficit hawks throughout the Obama era just to keep Obama from getting credit for anything, were slavering to stuff us all fatter on much higher debt as soon as they received full control of the kitchen.

While we had seen occasional trillion-dollar deficits during the so-called recovery period, they had not yet become the norm. Republicans made those high deficits the norm almost overnight: Starting from their 2017 apocalyptic deficit of $666 billion, Republicans approved a continuing resolution that added $200 billion (which is 20% of the new normal trillion-dollar deficit in just one new step). They took that leap without a hint that they will ever back that out of the budget in future years. From there, they created tax cuts that will add, at minimum, another $200 billion during each of the next ten years. Ta da, $1 trillion annual deficits for years to come! On top of that, our Republican congress and president are now grinding out a plan for additional fiscal stimulus spending and disaster relief.

I always believed Republican rectitude would end as soon as they controlled all parts of government, and clearly that has proven true. (It’s easy to sound like you have fiscal rectitude when all you are doing is complaining about what the other team is doing because you don’t have the power to enact your own wishes anyway. It’s quite another thing to restrain yourself from making all your own wishes come true when all the power is in your hands to make them come true.)

How the monster we fed will now swallow us

We are now ramping up government debt by orders of magnitude at the same time when interest on our mountains of debt will easily rise to 4% in about two years. I come by that number partly from the present rate of interest rise but mostly from the fact that the Fed is moving out of controlling the cost of debt, and will be doing so at a faster rate in the months ahead. (That is, if it stays with the program it has promised; and if it doesn’t, we simply have QE forever.) Mostly I come to it because 4% is the low side of what interest on the debt has historically been when the Fed wasn’t sopping up all government bonds, bills, and notes.

Interest rates have clearly started moving in that direction, tickling the toes of 3% almost every week. So, anticipating one more percent within two years is a conservative estimate since the cost of debt is far from priced in, having been artificially regulated down by the Fed for nearly a decade. The movement in 10-year and 30-year yields last month was the beginning of pricing in the Fed’s flight from financing the government, not the end. (I actually think it will rise a lot faster than that.)

Getting back to the low side of normal for interest on the national debt will increase the cost of maintaining that debt by a minimum of 50% over two years, and whatever happens to government interest rates always impacts consumer rates to an even higher degree. So, existing credit cards with variable interest, mortgages with variable interest will easily double in cost on levels of debt that many already find hard to manage. At the same time, new credit cards and mortgages will become so expensive that consumption will slow, not grow; housing will fall, not stall.

(Peak debt also includes corporate debt, but that could be alleviated by the government corporate tax cuts if those cuts are put toward paying off corporate debt. Peak debt also includes margin debt and other forms of debt within the stock market in addition to individual consumer debt and all of that government debt. I refer to all of those as “peak debt” because they are all at record high levels where any change in interest will have enormous impacts. Because interest on all of that debt is minuscule by historic standards, it is easy to double it. Small numbers double more easily than large ones.)

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