YOUGHAL, IRELAND – Today, we turn to something no one cares much about, even though it threatens to cause the biggest financial calamity in US history:
Total U.S. debt – public and private – now approaches $74 trillion. The economy that supports this debt has grown steadily, but nowhere near fast enough to keep up with it.
As we remarked yesterday, money is time. So when you owe money, what you really owe is time. And time is not something you can fool around with. It comes and it goes… no matter what you think or what you do.
Historically, Americans have owed 1.5 days of work in the future for every day of work in the present. That is, the ratio of debt to GDP averaged about 1.5 to 1 for the first eight decades of the 20th century.
Then, debt went up, and now stands at 3.5 days of future GDP for every day of present output.
Have we arrived in some great and glorious Valhalla, where the old rules no longer apply, where debt no longer matters… or where time is no longer our master, but our servant?
More Debt, No Problem
Whoa… we’re going a little too fast. Let’s slow down.
There are two reasons why debt is said to be no problem. The first, given by economist Paul Krugman et al., is that “we owe it to ourselves.” The second, proposed by Donald Trump, economist Gale Pooley, and others, is that we will “grow our way out” of it.
The first we can easily toss into the wastebasket. That “we owe it to ourselves” is merely an accounting identity. For every debtor, there is a debtee. For every dollar of debit, there is a dollar of credit. For every negative number on the left side of the ledger, there is a positive one on the right side.
But so what? That is just how accountants keep track. In the real world, the “we” is deceptive. Some people owe. Other people are owed.
John works for 20 years. He saves his money. He lends it to Tom. John has a credit equal to Tom’s debit. “We” are even.
John thinks he has 20 years’ worth of work and saving coming back to him, on which he intends to retire. And assuming Tom is able to earn and save money at the same rate as John, the former will have to devote 20 years of future work and saving to settle up with the latter.
All debt is essentially a contract between the past and the future. Money can be lent only if it has been earned in the past. Then, it can be repaid only if it is earned again… in the future.
But what if Tom can’t pay? Twenty years of work and saving will be lost. The world will be poorer as a result, and poor John will have to keep working as long as he is able.
On the books, Tom may still owe John exactly the same amount that he borrowed… and John may have a credit exactly equal to the amount that he lent.
But it is meaningless. A debt that can’t be repaid, whether owed to “ourselves” or to the King of Siam, is worthless.
But wait. John will write off the debt. He will lose his money. But Tom will be released from his obligation to pay. John will be poorer. But Tom will be richer. Even-steven, right?
Nope. Tom took John’s life savings and spent them. That wealth no longer exists. “We” are poorer.
Now let’s look at the other soothing lie – that we’ll “grow our way out” of debt.
As Krugman points out, in the emergency of WWII, the U.S. government borrowed a huge amount of money. But over the following decades, the economy grew faster than the debt. So like an aging movie idol, the WWII-era debt faded.
In 1948, it measured 126% of GDP; by 1980, it had shriveled to 42% and was scarcely recognizable.
But growing your way out works only if the emergency passes and GDP grows faster than debt.
Currently, with no Japanese bombers overhead… and no Wehrmacht tanks rolling down the Champs-Élysées… U.S. GDP is growing about 2% per year. U.S. debt, however, is growing at about $1 trillion per year… or about 5%.
And as we pointed out yesterday, this explosion of debt is happening less than two years after a big tax cut was supposed to boost GDP growth… and while we are at the tail end of a 10-year boom.
What will happen when the boom ends?
We’ll get to that in a minute. First, what about Mr. Pooley’s argument?
He says GDP measures fail to account for technological improvements… and that because of so much progress, the debt will be no problem. After all, the new iPhone is 120 times more powerful than the first one, and the new F-150 has 600 microchips. Surely, that will help Tom pay his bills, no?
Let’s see… how does that work?
In theory, the technophiles will say, innovation and invention will give Tom a higher rate of return for his time. But you can’t pay debts with computing power. You pay them with money. And where does money come from? Time on the job.
Inflate or Die
Wage growth rates have been coming down for the last 40 years. And despite more innovations than ever in history, real wages today are no higher than they were in the ’70s.
Now, at the end of the cycle, wages are said to be growing at nearly 5% per year. But come the crisis, and that wage growth will quickly disappear… just as debt shoots up even more.
And then what? Everybody knows what will happen.
No matter who is president, the U.S. is in an Inflate-or-Die trap. And nobody wants the boom to die. So, they’ll inflate more…
Bring on the quantitative easing, the shovel-ready programs… the tax credits… the student debt forgiveness… the Social Security increases… and all the other boondoggles that are supposed to make it easier for Tom to pay his bills!
In the coming crisis, U.S. deficits will increase to $2 trillion or more per year. Government debt will rise to $40 trillion… and beyond. Total debt – including corporate and household debt – will go over $100 trillion.
Little by little… and then suddenly… consumer prices will rise. And then, it will be a whole new ball game…