“My God, What Have We Done?”
by David Stockman
“And you may ask yourself, well
How did I get here?”
– Talking Heads, “Once in a Lifetime” (1980)
“The Turbulent Twenties and the baleful trends we talked about yesterday
have been gestating for decades. Their driver is the nation’s crushing total debt level. Combined public and private debt now equals $74 trillion. And the implied national leverage ratio has nearly tripled since the halcyon days of the mid-1950s.
We start with long view of debt and gross domestic product (GDP) because one toxic consequence of monetary central planning is the abolition of financial history. The market narrative is so oppressively focused on the most recent days, weeks, and quarters that a perverted structure is unthinkingly presumed to be normal, stable, and sustainable. It is not.
What was “normal” is evident in the figures for mid-1954. By then, the distortions of World War II and the Korean War were pretty much in the past, and the U.S. economy had embarked upon an extended period of solid growth, low inflation, and financial stability.
Total public and private credit market debt stood at $544 billion. GDP posted at $391 billion. The national leverage ratio – debt to GDP – was 1.39 times. It’s worth noting that this national leverage ratio had oscillated narrowly around 1.5 times for nearly a century, since the breakout of industrial growth after 1870.
The first major inflection point came in mid-1971, on the eve of Tricky Dick Nixon’s folly at Camp David. During the intervening 17 years, between 1954 and 1971:
• real GDP growth averaged 3.8% per year, and inflation had remained low most of the period;
• nominal GDP had grown by 6.6% per annum, and total public and private debt was up by 6.9%.
• Nominal GDP growth and debt growth tracked nearly the same path. That meant the national leverage ratio changed hardly at all – even though real growth and inflation posted the best 17-year trend of the 20th century.
Here’s the bottom line: The golden era of postwar prosperity occurred with virtually no change in the national leverage ratio at all – the boom was organic, a product of capitalism at work.
By the eve of Camp David, total credit market debt stood at $1.7 trillion. Nominal GDP posted at $1.16 trillion. The national leverage ratio was 1.47 times. When Nixon pulled the plug on Breton Woods and the gold-anchored dollar, total debt (the black stuff in the chart below) began to break away from nominal GDP (the purple part). That’s when the national leverage ratio began its long ascent from its historic 1.5 times trend line.
What followed between 1971 and 1987 was the raging double-digit inflation of the 1970s, triggered by a newly unshackled, money-printing Fed, and the deep recession of 1981-82, triggered by Paul Volcker’s about-face toward severe monetary restraint designed to smoother that raging double-digit inflation.
There were three recessions during that 16-year interval, which obviously didn’t do much for macroeconomic performance. The consumer price index (CPI) surged to 6.7% over the period while real GDP growth retreated to 3.2%. By contrast, the debt and leverage ratio leapt sharply higher. From 1971 to 1987:
• total credit market debt grew from $1.7 trillion to $10.7 trillion, or by 12.2% per year;
• nominal GDP rose from $1.16 trillion to $4.8 trillion, or by 9.3% per year; and
• the national leverage ratio spiked from its historic channel at 1.47 times in 1971 to 2.22 times.
Note that the smartly rising total debt and leverage ratio during that transition period didn’t deliver any economic goodness at all. A pattern of more leverage and less growth was already evident.
During the first 13 years of the Alan Greenspan regime at the Fed, the national leverage ratio leapt higher still. Between second quarter of 1987 and the beginning of the tech stock meltdown in the fourth quarter of 2000:
• total debt grew from $10.6 trillion to $28.6 trillion, or by 7.6% per year;
• nominal GDP rose from $4.8 trillion to $10.4 trillion, or by 5.9% per year; and
• the national leverage ratio climbed to an unprecedented high of 2.74 times.
During the early period of the Greenspan money-pumping era, however, the resulting stimulus to Wall Street supported a capital spending boom and flowering of technology innovation and adoption on Main Street. Accordingly, the CPI remained reasonably subdued, rising at a 3.2% annual rate during this interval. And real GDP posted at 3.3% per year – the same rate as 1971 to 1987.
During the first seven years of the 2000s, however, the Greenspan Fed cranked its money-printing policy into high gear, allegedly to reflate the economy after the mild recession of 2001. In fact, it was to bail out the punters on Wall Street. They’d been hit by an 85% meltdown of the Nasdaq 100, the “bust” to the dot-com boom.
This time, the leverage ratio soared yet again. That’s even as Main Street fundamentals deteriorated sharply. Between the fourth quarter of 2000 and the fourth quarter of 2007:
• total debt soared from $28.6 trillion to $52.6 trillion, an annual growth rate of 7.9%;
• nominal GDP rose from $10.4 trillion to $14.7 trillion, a far more modest annual growth rate of 5.6%; and
• the national leverage ratio erupted right off the charts, rising to 3.58 times.
• At the same time, real GDP growth weakened to 2.5% per year, and inflation remained at 2.4%.
At that point, the wheels came off the wagon. Twenty-four trillion dollars of total debt growth and a soaring and wholly unprecedented leverage ratio at 3.58 times national income was more than enough to send Wall Street crashing into the Global Financial Crisis and Main Street careening into the Great Recession.
After the fourth quarter of 2007, everything changed. The U.S. economy apparently reached “Peak Debt.” Accordingly, while both total debt and nominal GDP continued to rise by huge amounts, the leverage ratio remained flat, though stranded up in the nosebleed section of history. During the 12 years between the pre-crisis peak and the third quarter of 2019:
• real GDP growth slowed sharply to just 1.66%, the weakest trend growth rate since the Civil War, including the 1930s;
• total US debt grew from $52.6 trillion to $73.4 trillion, or by 3% per year, notwithstanding the “wake-up call” of the GFC;
• nominal GDP grew from $14.7 trillion to $21.3 trillion, or by 3.3% per year; and
the national leverage ratio weakened very slightly to 3.44 times.
The pattern is now clear. The nation’s leverage ratio has been steadily ratcheting upward for nearly 50 years. That’s even as real GDP growth has been driven steadily lower since the turn of the century.
Indeed, the chickens have been gathering for the trip home to roost for a long time now… And it seems as if the whole world has, indeed, gone mad.”
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