The debt level in this country has pushed our economy past a critical milestone. This 2009 analysis was intended to address the impact of accumulating debt as a method of revitalizing the economy. We have successfully used this technique for about 70 years. The natural inclination is to keep using that tool. Hugh McCoy's analysis has shown that tool is no longer useful after 2008. Any discussion of where to go from here is naturally speculative.
Am I missing important details and implications? My fear is that there is no way to perform the required market correction which does not also imply that 90% of Americans will then live below the poverty level.
It appears that the people who have been selected for this task have no clear idea how to get us out of this mess. If we also have no clue how to proceed, then we have effectively sanctioned their blunder into the ‘Disordered Correction’, or the even more disastrous ‘Debt Relief’, scenario.
Background:
Our last experience with an economic crisis has been called the Great Depression. The Great Depression also started out as a credit crisis. As one after another financial instruments froze up, the economy effectively stopped. Herbert Hoover believed that this market correction would be a short term phenomena, and required no intervention. His reasoning was based on lessons learned for previous recessions. 'Left alone, markets will stabilize themselves.'
What had changed was the invention of new credit instruments which allowed people to easily incur much more debt than could ever be paid. They could gamble with money they did not have. We have now repeated that mistake and compounded it.
Once initiated, the Great Depression refused to correct itself. Manufacturers reduced salaries and work force to accommodate the reduced revenue. Businesses failed as both credit and revenue dried up. As the customer base shrunk, monopolies like the utility companies raised their rates to maintain revenue.
FDR is often credited with ending the depression. It is not clear whether his policies would have actually worked in the long term, though several were very innovative. WWII came along and solved the problem for him.
The idea of raising prices to combat reduced demand does not make much sense to us today, but seemed to make perfect sense to these companies at the time. One of the most innovative policies for turning around the economy at the consumer level was forcing the utility companies to reduce their rates. The justification for this forced price reduction was that the utilities were an 'elastic market'. The concept of the 'elastic market' was still a new concept that had never been tried on a large scale. In an elastic market, reducing price creates such an increase in demand that overall, profit increases. We are all familiar with the concept today, but it was probably a revelation at the time. Obviously we need a new generation of innovative ideas for new times. We cannot expect to get these new ideas from people who still think we can simply spend our way to prosperity.
Our economy has a fundamental problem with productivity. Our products cost too much, and we prefer to buy stuff cheap. If we pursue a free market strategy then, at some point, a correction to work force compensation must occur. If, however, we pursue a protected market then the fundamental nature of our marketplace changes dramatically. If we pursue the current “spend to prosperity’ approach, then we are forced to consider a debt relief correction.
Free Market Correction:
In an ordered correction, the work force accepts a steady reduction in pay, as the price of our goods is reduced. A positive trade balance is created. The dollar stays strong and foreign investment is undisturbed. The average household is crushed under a debt load that will never be repaid. Businesses, however, are able to pay down their debt. This is the solution the financial sector would undoubtedly wish to pursue. It reduces the majority of Americans to debt servicing machines, while keeping large investors happy. This does not seem to be a likely scenario.
In a disordered correction, a few key sectors default on their debt. Foreign investors attempt to sell off their US assets. The value of the dollar falls through the floor. Triple digit yields are tacked onto bonds and T bills to slow the exodus of foreign cash. Double and triple digit inflation kicks in as a response to this market freefall.
When the dust settles, the dollar has about 10% of its current value, the US based financial sector is in shambles and the average worker has about the same inflation compensated wage as their Chinese counterpart. The total debt is much reduced in Yen, but is still the same percentage of the average American income as it is now. We buy substantially less foreign made products simply because they are too expensive. We cannot afford to buy very much, in any case. With a positive trade balance, however, it becomes possible to pay off corporate debt.
Protected Market Correction:
If we pursue a protected economy then different measures are taken. Extreme tariffs are placed on foreign goods to minimize domestic demand. These include goods manufactured by US companies in foreign countries, and components sent to the US for final assembly. In retaliation, few US goods are accepted abroad. All of our borders are fenced in and guarded to prevent the transport of cheap Black Market merchandise. Wages are protected, but prices rise dramatically because a larger percentage of goods have US manufacture. As a consequence, we experience double digit inflation. Foreign confidence in the US market falters as the country pursues economic isolation.
Those companies which can, will divest themselves of US holdings and move their capital to the developing Chinese market. It is difficult to estimate the impact of US economic and political isolation on the world economy. It will definitely be different.
Debt Relief Correction:
In this scenario the US has attempted to pursue the “spend to prosperity” policy for another 15 years. Our financial position is so precarious that no one will touch our T Bills or Bonds. In a desperate attempt to save ourselves we simply eradicate most of the debt and claim a clean slate. It is difficult to imagine this portion of North America existing as the United States for much longer after that. Such desperate measures seem unthinkable now. However, these measures will look like the only way out, if we attempt to ignore the debt crisis.
HHMcC - 2009 correspondence
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