Friday, September 29, 2017

DANGER: Rising Debt Levels

Global debt levels reached an astronomical $217 trillion in the first quarter of 2017. That's 327 percent of the entire world's economic production (GDP.) Before the financial crisis, global debt was “only” around $150 trillion, meaning almost $120 trillion have been added to the debt in a mere decade.

For individual countries, analysts generally consider a debt-to-GDP ratio above 80-85 percent to be “unsustainable.” A “sustainable” debt-to-GDP ratio is one in which payments are made on time and in full and with the expectation the debt will ultimately be eliminated. The U.S. debt-to-GDP was 106.1 percent in December 2016.

Neither U.S. debt nor global debt will ever be repaid, because both are not only too large to pay now but growing faster than incomes, putting repayment further out of reach. This is true not only for government debt but private debt as well. According to the Bank for International Settlements, household and corporate debt in the world economy, as a share of GDP, amounted to 138% in 2016, compared with 115% at the end of 2007. For advanced economies, that ratio was even more dangerous, averaging 195% last year, compared with 183% at the end of 2007.” And with only a few exceptions, most countries' public debt rose significantly over the same period. So indebtedness in the world is far higher today than at the start of the financial crisis.

At the depth of the financial crisis a decade ago, the Fed launched a huge increase in the money supply to prevent collapse of the banking system. The government rescued Fannie Mae and Freddie Mac and bought hundreds of billions of dollars of their debt and mortgage-backed securities. Later it decided more monetary stimulus was needed because the economy was not rebounding as hoped. So two other bond-buying programs (“quantitative easing”) were initiated in the hope driving down interest rates to stimulate consumer buying and spur the economy. While some financial markets enjoyed a recovery, the expected overall economic growth proved elusive.

After a decade of relative economic stagnation, the Fed has now decided to unwind the $4.5 trillion of Treasury bonds and mortgage-backed securities it has accumulated. It cannot hold interest rates near zero forever since there are market forces at work for higher rates and ignoring them would create further economic imbalances with adverse consequences worldwide. The Fed will reduce its holdings very slowly, at first by $10 billion a month for three months, and then by a further $10 billion every quarter to a maximum of $50 billion a month, or $600 billion per year.

No central bank has ever been in the position the Fed is now in. None has ever had a trillion dollars and tried to divest itself of them. Austan Goolsbee, who headed the White House Council of Economic Advisers under Obama, said, “The final exam, with the grade yet to be determined, is can the Fed actually get out of this stuff.”

David Blanchflower, an economist who was on the Bank of England's monetary policy board, which faced the same problem as the Fed, says when the bank began this unconventional campaign (i.e., quantitative easing) “we had no idea what we should buy, how much, for how long,” and there was no idea on the way of getting out.

Double-entry bookkeeping is the basis of accounting. If asset values fall, then so too must total liabilities. As explained by Mervyn King, former governor of the Bank of England (the central bank of England, like the Federal Reserve in the U.S.): “For companies and banks, their assets are the future stream of earnings discounted back to the present, while their liabilities are the amounts owed to creditors...and the residual value of equity. So as interest rates rise, the discount rate will increase and asset prices will fall relative to incomes. A squeeze on the value of total liabilities falls initially on the value of their equity, making it more difficult to borrow. But it also increases the likelihood that some companies and banks will default on their debts. We could see a sequence of defaults in different sectors of the economy and in different countries.”

The problem of the Fed in shrinking its balance sheet by unloading its bonds and mortgages is discussed more fully in my book The Impending Monetary Revolution, the Dollar and Gold, including penetrating inputs by monetary experts Gramm and Saving. Here are some samples:

"Fed will have to divest its $1.4 trillion of mortgage-backed securities (MBS). This would send mortgage rates spiraling even if sales were spread over several years.

"Fed would still need to sell about $600 billion of U.S. Treasuries to reduce excess reserves in the banking system.

"Every increase in interest rates drives down the market value of Fed's Treasuries and MBS holdings, forcing it to sell more and more to lower the monetary base by the required amount. This depletes both the Fed's asset holdings and earnings.

"The monetary expansion that started as a response to the subprime crisis has evolved into a prolonged and largely unsuccessful effort to offset the negative impact of the Obama administration's tax, spend and regulatory policies....No such explosion of debt has ever escaped a day of reckoning and no such monetary surge has ever had a happy ending." (Italics added.)

It should be remembered that the Fed totally missed predicting the Great Recession. It said the worst that could happen would be a very mild recession. Recently the Wall Street Journal recalled this by writing on September 21, 2017: “Given the way that investors are obsessing over the Federal Reserve's most recent economic projections, it is a good time to look back on where they were 10 years ago...In September 2007, it was clear something was amiss with the U.S. economy...Fed policy makers were worried...But their projections show they expected the storm to pass quickly. They thought unemployment would only inch up a bit over the next several years, never topping 5%. The economy would expand 2.2% in 2008 before picking up to 2.5% in the following years. Inflation would settle into just under a 2% rate. Three months later the recession began.”