Money management firm Van Hoisington is out with its latest Quarterly Review and Outlook.
Authored by Van R. Hoisington and Lacy Hunt, the letter fires a warning about elevated government debt levels, echoing the work of Carmen Reinhart and Ken Rogoff.
They start by arguing that all this debt has done us no favours.
The standard of living of the average American continues to fall. Real median household income today is near the same level as it was fifteen years ago, a remarkable statistic since the debt to GDP ratio is 100 points higher. The cause of this deterioration in living standards can be traced to the excessive accumulation of debt, as well as the debt proportion that has turned increasingly unproductive, or even counterproductive. When debt is utilized to finance nonproductive assets, an economic process is initiated that undermines prosperity.
Even worse, is “the negative feedback loop arising from the unproductive nature of this debt accumulation.” They identify and break down three problems with debt-financing:
- “First, United States government spending carries a zero expenditure multiplier, as do operating expenditures of state and local governments. Thus, each dollar spent by the federal government creates no sustainable income, yet the interest payment incurred with each borrowed dollar creates a subtraction from future revenue streams of the private sector.”
- “Second, much of the massive debt increase over the past decade has been in the form of mortgage debt. Jobs and income were created with the expansion of the housing stock. However, no productivity gains are evident in this housing stock increase, which means future incomes have not expanded. Nevertheless, the repayment of principal and interest weighs down the system, and the consequences of delinquency, foreclosure, default and bankruptcy compound the problem.”
- “Third, debt that is utilized to finance consumers’ daily needs obviously fails to generate any productivity or future income growth. Efforts by fiscal and monetary authorities to sustain growth by further debt accumulation may produce some short- term benefit. Sadly, these interludes fade quickly as the debt becomes more destabilizing. The net result of increased indebtedness then becomes the opposite of what policymakers intend when they promote economic growth by either borrowing funds for increased government expenditures or encourage consumers to borrow with artificial and temporary incentives.”
The real worry is that the mounting debt could lead to the “bang point”:
There is a longer-term negative feedback loop that has been referred to as the “bang point” by economists Reinhart and Rogoff, and it occurs when government or private borrowers are denied access to further credit because the marketplace has no confidence that new or existing debt can be repaid. At this point interest rates soar and debt issuance becomes impractical; therefore, the government or private borrower is forced to live on current revenues. As recent cases in Europe have documented, this is painfully disruptive, with high social costs.
The good news is that Van Hoisington think we’re at the “bang point” just yet.
We do not believe this point is at hand for the United States, but it has occurred many times historically, including in contemporary Europe. If it were to happen in the U.S. now, the consequences would be traumatic since 42 cents of every dollar spent by the federal government in the first six months of the current fiscal year was borrowed. The chaos that would be created by a reduction in federal government spending of 42% is unimaginable.
Ultimately, the authors warn that the U.S. needs to act before we actually hit the “bang point.” There prescription:
From both economic theory and historical experience the answer is clear; austerity is the solution to too much debt.
Read more at HoisingtonMgt.com.
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