John Kemp at Reuters decomposes and thereby illustrates, if unknowingly, the tractor beam that now grips the US economy:
After six decades of uninterrupted credit creation and an unprecedented era of consumption and prosperity, the credit process has come to an abrupt halt. If credit has been the locomotive of the modern economy, the third quarter of 2008 marked the point when the engine stalled and the economy began to roll back down the hill.
For decades, financial activities have grown much faster than the real economy. Between 1952 and 2007, U.S. nominal GDP grew by a factor of 39 times, while total credit market debt outstanding surged 101 times.
Finance has become even more dominant in the last 25 years, as subdued business cycles, improvements in technology and communications, deregulation and pension privatization have fueled a massive increase in the issuance of debt and other financial assets.
In 1952, the U.S. economy had just $1.28 of debt for every dollar of GDP, and as late as 1980 this figure was still as low as $1.61. But beginning in the 1980s, financial services underwent a revolution that saw credit instruments per dollar of GDP rise to $2.28 in 1990, $2.67 in 2000 and a staggering $3.55 by the end of 2007.
Let's stop here and give thanks that for once we see total debt as a function of GDP, not just government debt, for when only the latter is quoted, it is almost immediately compared to like figures for Japan or Italy with a wink: things ain't so bad, see? No, what distinguishes the US from other debtors is the total absence of local creditors. In Japan, for example, households saved like squirrels while workers toiled like ants; net-net, their "lost decade" saw the country get richer, even as one component -- government -- went into hock. The US has no such crutch.
Ok, now for the simple math part: what is masked by these figures is the contribution of debt to GDP -- this ratio is, in some respects, a "biased" ratio, for debt expansion contributes to GDP expansion. What happens to the quotient if you fix the numerator? For this appears to be happening now:
But in the three months between July and September, the miracle of modern finance came crashing down.Despite the turbulence, total debt rose another $585 billion, according to the Federal Reserve’s “Flow of Funds” report issued yesterday. But almost all the increase was government borrowing ($527 billion) to backstop the Federal Reserve and other rescue programs. The private sector borrowed just $58 billion.
So, the private sector stops borrowing and what happens to the GDP? It starts cliff diving. (And note, this is even as the government keeps expanding its balance sheet.) Looked at arithmetically, if the borrowing -- the rate of increase in the numerator -- slows down, the output -- the denominator -- starts to decrease. In other words, the US needs to borrow just to stay even. Question: given these dynamics, how is the quotient, the debt to GDP ratio, ever supposed to decrease? Put differently, how can the US ever pay back the debt?
It seems clear that it can't pay back the debt. Not ever. Rather, as they say, the US shall wear this debt. We've seen companies get trapped in debt-powered death spirals, but the world's largest economy? Den mother to subordinate economies? No, we're going Lehman or we're going Weimar.
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