For the past 40 years we have been going through a transition of being a nation of producers to a nation of consumers. In the 1970's we were the worlds largest industrial power and in turn, the worlds largest creditor. Now, just 30-40 years later, we are not the producers we once were and we are the worlds largest debtor.
Let me start with a little basic history:
Right now, in 2010, our national debt in relation to GDP is 94.1%. Put that along with the 120% increase to the U.S. cash supply we have flooded the world with over the past 2 years and you have a problem larger than we have ever known.
Anyone who has been following my posts knows about the inflation of the 1970's when the cash supply was increased by a mere 13% and how we needed to raise the interest rates to a record 20% to control the issue. I have also been hit with comments about the fact that after World War II, our national debt in relation to GDP was 125%. In actuality, the national debt to GDP was higher back then (debt was actually 121% to GDP), but the situation then was not nearly as grave as it is now.
Let's try to think of the United States as a business. Anyone with any business experience knows a certain amount of debt is required to grow. However, there are two basic types of debt - and the distinction between the two couldn't be more important. Capital debt and Consumer debt.
Capital debt is investment debt. Debt used to create growth. Capital debt would include any loans made to businesses to finance capital formation. An example of this would be an auto company using financing to build a new production factory. The earnings made from increased production enable it to pay both the interest off the debt and repay the principal. Anything left over is profit which the business will have earned for its success. This type of debt leads to improvements in standard of living and ultimately lead to greater cash flow and savings.
On the flip side, Consumer Debt, is money borrowed or lent to finance consumption. When money is borrowed to consume, there is no income-producing asset acquired. Therefore, the loans can only be repaid out of reduced future consumption. Society does not benefit from consumer debt. In fact, society suffers from consumer debt.
Granted, a certain amount of consumer in inevitable in any economy. Some might argue consumer debt is required. After all, how can the producers save if not for the consumers spending? "Amazingly, we managed to become the wealthiest industrial nation in the history of the world without a single credit card or home equity loan" (Peter Schiff).
Why is it spiraling out of control at this time? Well, the last two times we had such financial crisis' in this country were the two mentioned earlier - the end of the 1970's and after World War II. At those points, we were the strongest industrial power in the world. Much of our debt was owed to ourselves. The interest payments made stayed in the country as profits, which in turn equalled purchasing power. Now our debt spread out around the world. China owns 21.9% of all U.S. treasuries, Japan owns 19.8%, the UK owns 8.8% and Brazil and Russia own a combined 5.3% of U.S. treasuries. That is 55.8% of our U.S. treasuries owned by other countries. (wikipedia)
Why is this a problem? Well, for starters, it is the single greatest transfer of wealth this world has ever seen. When our debt to GDP hit high levels in the past, it wasn't nearly as big an issue as it is now because, in fact, a major percentage of that money was paid to ourselves. Now however, the interest paid (purchasing power) is going directly to China and other developing nations.
Another issue: From 1960 to 1980 consumer expenditures as a percent of GDP were anywhere from 61-64% of GDP. With the advance of the credit card in the late 1970's and early 80's, consumer debt as a percentage of GDP surged to 70% over the next two decades. However, that is not the only part of the equation. With more spending comes less savings. The personal savings rate of this country fell from 12% in 1980 to under 2% in 2007. (financialsense.com) Wealth is no longer judged by how much you save, but by what car you drive and what kind of clothes you wear.
Credit cards are not the only issue, however. Our debt as a nation is not due only to credit cards - they were just the kindling that started the fire. I think credit cards were just the beginning to the immediate gratification mindset most americans now live with. It is no coincidence that as our personal savings rate has dropped just over 10% since 1980, our household debt in relation to GDP has also risen from just over 60% to just over 130% of GDP in that same timeframe. Also no coincidence is the spike from 2000-2007 where it went from 90% of GDP to 130% of GDP as people spent more and more using their homes to get more money.
During the real estate boom, people used their houses like ATM machines, withdrawing $1.9 trillion in "equity" from 2005-2007 when homes were at their peak value. Of course, as we all know, many of those homes are now under foreclosure. By next year there are going to be an estimated 19 million foreclosed homes on the market. On a positive note, I think people are starting to feel the impact of the economy. Since 2007, personal savings rates have risen from just under 2% to around 5%. That is obviously a great sign. However, the savings rate would need to hit 14% before they are able to cover retirement. (financialsense.com)
I could go on and on with statistics that prove our dire situation. Let me just get down to the point. Our government and the mass population of our country have been building debt for the past 30 years. As housing prices drop through the floor (because of supply/demand issues and the fact interest rates NEED to rise), our debt to GDP ratio only worsens (as a result of home equity cash outs at the peak of the market). The worst part of this situation is we have no way to pay off the debt on either end of the spectrum. As a nation, we are over $13 trillion in debt. We have had a trade deficit of $34 billion or more per MONTH every month of 2010 (americaneconomicalert.org). With a national trade deficit that large, the debt only grows. In addition, all of the interest paid on our treasuries is no longer being paid mainly to the people of the United States. As I said earlier, over 50% of U.S. treasuries are owned by foreign entities. This means we are paying interest on dollars loaned by them. That interest paid goes directly to those foreign entities, thus upping our consumer expenditures while upping their savings rates. There is a mass shift going on in the world economy right now, and the United States is not on the positive side of the spectrum.
Lastly, I have mentioned to a couple people in person about the bond bubble to come. Many have said this is impossible. Let me simply let you know what Peter Schiff has to say about the issue and see what you think then.
"Rates on long-term Treasury bonds remained artificially low in the first months of 2009, meaning that bond prices (yields and prices being on the opposite ends of the seesaw) remain artificially high. The benchmark federal funds rate, in a target range of zero to 1/4 percent since December 2008, has failed to provide stimulus and the Fed has been making massive purchases of Treasuries in an effort to keep rates down. The 30-year yields held in a range of 3 to 4 percent from November 2008 thru May 2009, representing record lows. In fact, in mid-December 2008, the yield fell to an all-time record low of almost 2.5 percent.
Since no rational investor would buy 30-year bonds at such low rates with the intention of holding them to maturity, it is obvious that high bond prices are unsustainable. I believe leveraged hedge funds and other speculators are buying long-term Treasuries because they think their value will rise in the short term as the Fed proceeds with its announced programs to make purchases in the trillions of dollars. Foreign central banks are still buying, but are waking up to the fact that their risk is not default but reduced purchasing power.
When the dynamics reverse, these bond flippers, like the condo flippers in the real estate bubble, will go into sell mode. With a preponderance of sellers and few buyers, the bubble bursts. The greater problem comes as the Fed increases its purchases to pick up the slack. Since bonds merely represent future payments of dollars, as the Fed prints dollars to buy bonds it further lessens the value of those bonds left outstanding. This only chases more buyers away, necessitating even more Fed purchases and setting a vicious cycle into motion. Eventually the Fed remains the only buyer. However, given how fast the dollar loses purchasing power once this situation develops, the government must borrow even larger quantities to fund its rapidly rising expenditures. Once this dynamic sets in, hyperinflation is the result."
He went on to say, "So as this final bubble bursts, we are faced with a self-perpetuating spiral. The more bonds the Fed buys, the more inflation it creates and the less the dollar is worth, making our bonds less attractive to outside buyers. That makes the bonds being currently issued a harder sell, never mind the multiple trillions of dollars that will have to be raised to finance President Obama's recovery program. Not only are foreign investors going to be inclined to pass on that debt, but I would also expect that with all the buying the Fed is doing, foreign investors would have second thoughts about continuing to hold the bonds they already own. That's why I say the real collapse is still coming. We've really seen nothing yet. The fact that foreign governments have been willing to lend us money this long has permitted the bailouts and postponed the pain."
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