We Have a Debt Problem

In 1957, a dollar of debt produced $0.54 of additional income. No longer. Debt has increased more than twice as fast as the growth of the economy.

You live in a period of “crisis.”

I mean that literally. As defined, a crisis is “an unstable or crucial state of affairs,” and “the period of strain following the culmination of a period of business prosperity when forced liquidation occurs.”

Hints abound that the status quo is exhausted and the crisis of liquidation approaches. Indeed, it has already begun.

I don’t know whether you caught the story about the sale of the Galleria shopping mall at Pittsburgh Mills. The property was worth $190 million in 2005. It sold on January 18 to Wells Fargo in a foreclosure auction for $100. That is not $100 million or even $100,000.

That is $100. A single Ben Franklin.

According to CBS Pittsburgh, the remaining balance on the mortgage was $143 million. Even with a Macy’s store taking up a lot of space, the mall was nearly half empty. So much for the vigorous recovery.

The Wall Street Journal in January reported the revised Education Department numbers now show the level of student loan paybacks is far worse than previously stated. No, they did not “lowball” the total owed — that has now hit $1.4 trillion.

An amended analysis showed that of more than 1,000 higher-learning institutions, half or more of the students failed to pay down even $1 over the last seven years. This not only speaks of a staggering problem of bad student loans, it also reflects the fallout from the end of growth.

Simply put, growth in the U.S. and all the developed countries has dwindled to the vanishing point.

The end of growth, initially only a slowdown in the early 1970s, was patched over by the greatest explosion of credit in the history of the world. This amounted to a complete perversion of capitalism.

All the advanced countries followed our lead into a system in which central banks create unlimited money to subsidize activities that no longer pay their way.

America’s Debt Problem

Over the past four decades, the economy has been propped up by ever-increasing emissions of debt.

Karl Marx rightly derided this as “fictitious capital.” The mushrooming “fictitious capital” is both a cause and consequence of the end of growth.

For better perspective, roll back the clock to 1957, the year President Eisenhower started his second term in office. In those long-lost days, when America’s economy was unquestionably great, public and private debt amounted to about $5 trillion, or 186% of national income.

In Eisenhower’s time, a dollar of debt produced $0.54 of additional income. No longer. Debt has increased more than twice as fast as the growth of the economy.

Annual growth in real gross domestic product (GDP) per capita over a decade dwindled to 0.5% in 2016 — just one-seventh the GDP per capita growth rate over 10-year periods from four decades ago. Real per capita GDP growth has fallen by 86% since those days. Over the years, households tried vainly to maintain living standards in the face of stagnant or falling income by borrowing vast amounts. That worked until it didn’t.

Growth is destined to fall into negative territory, as debt compounds to its unhappy limit.

If this is not obvious, it is because too many economists formulate their views of the economy without consideration of our position in the debt supercycle.

If you wonder what the debt supercycle is, let me explain. In simple terms, it is a consequence of the buildup of government intervention in the economy.

You see, the government lives by this theory that if it simply spends money when the economy is doing poorly, even if that money is borne of debt, things will improve.

The consequence?

These automatic stabilizers by the welfare state prevented (or perhaps merely postponed?) severe declines in activity while permitting a continued buildup of debt.

As debt increases over time, the ratio of added GDP to added debt deteriorates. In other words, the power (or what is known in econospeak as “marginal productivity”) of debt to act as a stimulus plunges.

For example, years ago, a dollar of debt may have led to 85 cents of real economic activity. But as more debt was piled on, a dollar of debt leads to less real economic activity.

In other words, debt loses its power to juice the economy.

The reason why this happens is easy enough to understand: As debt grows, it costs more to service. It hinders both the production and consumption side of the economy.

After all, if more cash must be used to pay off principal and interest, then there’s less money for increasing production or hiring more workers.

As debt grows, output slows or declines. Hence, the drop in the marginal productivity of debt. We get more debt, but less economic activity for each dollar borrowed.

The result is stagnation as interest payments due on old debt overwhelm the income earned from the diminishing amount of growth stimulated by new debt.

Welcome to Hyperdeflation

As of December 31, 2015, total public and private debt in the United States hit $63.5 trillion (a conservative estimate) in an $18 trillion economy. There were 3 1/2 dollars of debt burdening each dollar’s worth of economic activity. If the average interest rate payable on the outstanding debt was only 2.5% (check your credit card statement for comparison), the nominal growth of the economy would have had to be 8.8% to prevent it from crumpling under the burden of escalating interest payments.

In fact, in dollar terms, the nominal growth of the U.S. economy in 2015 was just $439.2 billion — less than a third of the $1.587 trillion that would have been required to break even on interest payments.

This implies that the growth-stunted economy is under ever-greater pressure to contract.

In the decade since 2007, nominal economic growth in the U.S. averaged just 2.92%, implying a widening gap between the liquidity earned from economic growth and the compounding interest due on mushrooming debt.

Contrary to what most economists and investors suppose, ever-expanding debt is deflationary. We can’t just go merrily along spending ever-greater sums out of an empty pocket. The cost of even attempting that has been grossly underestimated.

Look at the record. Growth has slowed from decade to decade as debt soared like the trail of a rocket headed into space. But the rocket is destined to fall back to earth.

A New Opportunity

Looking forward, the results to be expected are growing illiquidity and debt distress culminating in a corrective deflation that unwinds the debt supercycle. In other words, as I outline in my book, The Breaking Point, even with the lowest interest rates in 5,000 years, we face an “inevitable crisis.” That is a term coined by F.A. Hayek in the 1970s — about the time when American economic growth ceased to be “great.”

In a world that is past the point of no return in the debt supercycle, the conventional view would be to expect a business cycle correction. But we could be in store for something more drastic, as the entire modern period of economic growth stumbles to a halt.

Bear in mind that a world-shaking crisis is both a time of danger and opportunity. Opportunity is always greatest when the market is mispricing assets because people “don’t get it.”

A choice for profiting from the run-up to the breaking point would be to position yourself long the dollar. I have also provided my Strategic Investment readers three options for taking advantage of the opportunities that are coming. You can learn what those are by clicking here.


James Dale Davidson
Editor, Strategic Investment