Comstock Partners has a new newsletter out, and it makes a cogent case that there is no pretty way out of our over-leveraged mess. The disheartening bit is not only the narrative but a series of charts. One, on debt to GDP, show that it has risen in the last year (debt was roughly $49 trillion as of last year, it is not $52 trillion this year). So we have had a lot of economic pain with NO reduction in aggregate indebtedness, This isn’t simply shifting private debt onto the public balance sheet (in effect); this is actually an increase in the underlying pathology.
That debt to GDP chart is controversial, because the comparability of older data to current figures is debatable. But the key message is that debt to GDP shot up after the stock market fall in the Great Depression due to the collapse in GDP. And while large scale deficit spending did help pull the economy out of the rubble, it was also accompanied by large scale debt reduction, via bankruptcies and bank failures (not pretty, mind you) and restructurings. But in this time around, there is perilously little in the way (yet) of restructurings of underlying debt. That does not bode well for recovery.
From Comstock Partners (hat tip DoctoRx):
We are in the process of deleveraging the most leveraged economy in history….this deleveraging as a major negative that will weigh on the economy for years to come and we could wind up with a lost couple of decades just as Japan experienced over the past 20 years. It is true that Japan didn’t act as quickly as we did but our debt ratio presently is much worse than Japan’s debt ratios throughout their deleveraging process…
This seems to us to be a “mini bubble” of stocks reacting to an abundance of “money printing” by governments all over the world since stocks are rising worldwide. Of course, if the U.S. doesn’t recover there will be no worldwide recovery since the rest of the world is still dependent upon the U.S. consumers’ appetite for their goods and services (despite the so called growth of domestic consumption in China and India). We, however, don’t believe that the U.S. massive stimulus programs and money printing can solve a problem of excess debt generation that resulted from greed and living way beyond our means. If this were the answer Argentina would be one of the most prosperous countries in the world….
Most investors believe the bailouts, stimulus plans, and quantitative easing will lead to inflation. In fact, almost all of the bearish prognosticators are negative because of the fear that interest rates will rise once the inflation starts to work its way into the economy. They point to the doubling of the monetary base which they believe will soon lead to rising prices as more dollars are created chasing the same amount of goods. We, on the other hand, are not as concerned about the doubling of the monetary base because we believe the excess money will need the money multiplier and increases in velocity in order to increase aggregate demand and eventually inflation. As long as velocity (turnover of money) is stagnant we expect the increases in the monetary base and all the quantitative easing will lead to a stagnant economy and deflation until the consumer goes into the same borrowing and spending patterns that was characteristic of the 1990s through 2007.
Yves here. This point echoes a Gillian Tett piece today. Back to the newsletter”
Remember, over the past decade (when we believe the secular bear market started) the total debt in the U.S. doubled from $26 trillion in 2000 to just over $52 trillion presently (peaking a few months ago at $54 trillion). This consists of $14 trillion of gross Federal, State and Local Government debt and $38 trillion of private debt. We expect the private debt to continue declining in the future as the deleveraging of America unfolds, while the government debt will very likely explode to the upside as the government tries to slow down the private deleveraging by helping out the entities and individuals in the most trouble with debt (such as over-extended homeowners).
We wrote a special report in January of this year titled “Substituting Debt for Savings and Productive Investment” in which we explained why the U.S. economy historically prospered because of hard working Americans saving a substantial amount of their income which was used for productive investment. Unfortunately, all of this changed over the past few decades and got worse over the past decade. In fact, we stated in the report that it took $1.50 of debt to generate $1 of GDP in the 1960s, $1.70 to generate $1 of GDP in the ’70s, $2.90 in the ’80s, $3.20 in the ’90s, and an unbelievable $5.40 of debt to generate $1 of GDP in the latest decade. Over the past two decades, while most investors thought this trend could continue indefinitely, we have been warning them of the catastrophic problems associated with this ballooning debt….
We expect the total debt in the U.S. to decline during the deleveraging period directly ahead, with the government debt exploding while the private debt collapses. The private debt in Japan was almost the reverse of the U.S. where most of our excess debt was in the household sector and most of the excess debt in Japan was in the corporate sector. The debt to GDP figures in Japan were not easy to come by from the typical sources until the mid 1990s and had to be estimated, but should be pretty close to the numbers used above. Our sources on the above Japanese debt figures came from Ned Davis Research and the Federal Reserve Bank of San Francisco. NDR’s report, “Japan’s Lost Decade– Is the U.S. Next?” have great statistics and information and the Fed’s report “U.S. Household Deleveraging and Future Consumption Growth” is well worth reading.
The Fed study charted the peak of the debt related bubble of the stock and real estate assets in Japan in 1991 (1989 for stocks and 1991 for real estate) and overlaid it with the peak of U.S. debt associated with the same assets in 2008. They concluded that if we are able to liquidate our debt at the same rate as Japan we would have to increase our savings rate from the present 6% (artificially high due to the recent stimulus paid to households) today to around 10% in 2018. If U.S. households were to undertake a similar deleveraging, the collective debt-to-income ratio which peaked in 2008 at 133% (H/H debt vs. Disposable Personal Income) would need to drop to around 100% by 2018, returning to the level that prevailed in 2002.
If the savings rate in the U.S. were to rise to the 10% level by 2018 (following the Japanese experience), the SF Fed economists calculate that it would subtract ¾ of 1% from annual consumption growth each year. We did a weekly comment about this very subject on June 25 of this year and came to a similar conclusion. In that same report we showed that from 1955 to 1985 that consumption accounted for around 62% of GDP. Because of the debt driven consumption over the past few years at the end of March 2009 consumption accounted for over 70% of GDP. If the percentage dropped to the normal low 60% area of GDP it would subtract about $1 trillion off of consumption (or from $10 trillion to $9 trillion)….
We expect that the U.S. deleveraging will follow along the path of Japan for years as real estate continues to decline and the deleveraging extracts a significant toll from any growth the economy might experience. We also expect that, just like Japan, the stock market will also be sluggish to down during the next few years as the most leveraged economy in history unwinds the debt.
The newsletter also has some charts (not in the text, you need to click on them…..I figured I’d send the curious over there).