Debt: America’s Greatest Enemy

So why is debt such at bad thing? Why all of a sudden is it bringing people and countries to their knees? It’s not new, in fact it’s been with us as long as money has. Debt can be a really great tool that allows us to buy more of a thing or to buy that thing much sooner than we could with only our cash. And there are some things we might not be able to buy at all without debt, like houses, roads, or college.

The essence of the answer is quite simple. Debt presumes on the future. When one undertakes a debt, he, she, or a collective assumes that circumstances will continue to favorably support the repayment of the debt until it is satisfied. We clearly understand what happens when we as individuals or corporations lose our ability to pay our debts. Because of the Great Recession, we are getting an education from Europe as to what happens to countries and their citizens when they can no longer pay their debts.

The images of Greek citizens rioting and destroying the fabric of their nation serves as a stark warning of what can happen when a country nears bankruptcy. But Greece is small enough to be bailed out. As the recession in Europe worsens so does the ability of larger countries like Spain, Italy, and eventually France to repay their debts.

The US is fortunate to have it’s debts denominated in the global currency. This status forces the world to carry our debts at significantly higher levels than would be tolerated of other nations. However, cracks are forming in the foundation. Last year, Standard and Poor’s downgraded US Treasury debt from its vaunted AAA status to AA+ and they may soon do it again. Our government was unable to responsibly address our mounting debt problems last year to prevent the downgrade of Treasuries last year and they remain unable to act now under the threat of elections.

While credit downgrades and potential default are the obvious threats of too much debt, there is a more subtle problem we don’t hear about on the evening news or CNBC. It is that the American standard of living is falling. Real median household income today is near the same level it was fifteen years ago,

while the ratio of debt to Gross Domestic Product has risen alarmingly fast.

Lacy Hunt and Van Hoisington observe that “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. Productivity gains must be generated in order to boost income, and thereby the standard of living. If debt enhances productivity, incomes will expand and the economic pie will be enlarged. Otherwise, the debt increase exercise is debilitating to economic growth.”

Nothing crushes innovation, production, and purpose more effectively than debt, and particularly at the levels of which governments are capable of creating it. Government debt is not only unproductive, it is anti-productive. When the government borrows money, the Treasury unfairly competes with individuals and corporations who borrow for productive purposes, like buying homes, investing in a small businesses, and building more efficient manufacturing plants. Lacy Hunt and Van Hoisington put it this way: “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.”

Government borrowing steals not only from our own future but from the generations to come. We borrow today largely out of self interest and we saddle (literally in the case of social security) the next generation with the compounding bill (debt plus interest plus interest on the interest). There is another less obvious, and even greater cost to debt that is almost always ignored. We understand the initial cost of debt, which is interest, but we are so near-term focused on what we want now that we pay little attention to the opportunity cost to our future. Every dollar we spend on interest might otherwise be invested to harness the immense power of compounding to work for us, not against us, as it does with debt.

Nowhere is the tragedy of debt greater than with our youth. The higher education system in the US has become so expensive, primarily because of government-enabled low-cost debt, that most students are forced to borrow large sums to get their degrees. Look at the graphs below to see how fast college tuition has grown relative to other necessities.

Our system is literally teaching and encouraging our children to leverage their future to get a college education. As a result we rob them of one of the greatest assets they have for savings – that of time. Their early years are compounding against them rather than for them. As you can see below, the average student loan debt for batchelor’s degree recipients is just under $30,000. Worse, two thirds of batchelor’s degree students ‘graduate’ with debt.

So our problem seems to be not only one of huge and growing debt, but more fundamentally a mindset or acceptance of debt as the only course. There is another way. It’s productive gorwth, but it is bocomming less a possibility as debt grows.

In the 1920’s the US accumulated a massive amount of unproductive debt. Hunt and Hoisington suggest that the ultimate solution to that conundrum “was a period of austerity in which the savings rate soared . . . from 1929 to 1950. During that period in the United States, the excessive debt of the 1920s was dramatically reduced and created the basis for post WWII US prosperity. The mandatory rationing in the United States during World War II, combined with the income generated gains in exports of virtually everything we could produce from US farms, mines and factories pushed the US personal saving to a peak of more than 25%. This [combination of savings and exports] permitted the excessive debt of the 1920s to be paid down. The current low level of US saving precludes the same resolution to the debt problem seen in the 1920s case, but is similar to the current Japanese situation.” Japan is now twenty years into recession/deflation largely because the government has failed to adequately address its debt through austerity measures.

Will we learn from our own history and from what we see happening before our eyes in Japan and Europe? If we do not economists Reinhart and Rogoff suggest that a “bang point” likely awaits the US. The ‘bang’ 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.” Do you catch the irony – austerity if you do, austerity if you don’t?

But don’t think for a minute  that the levels of managed austerity are anywhere remotely comparable to the austerity that results from inaction. The US currently borrows 42 cents of every dollar it spends. Consider the chaos suggested by Hunt and Hoisington that would ensue if the US were to reach a “bang point” at this rate of borrowing. Can you really imagine what would happen if the US government had no alternative but to cut spending by 42%?

So it looks like austerity is the solution and controlled or managed austerity is better than forced austerity. Hunt and Hoisington quote a McKinsey Global Institute study that examined 32 cases where extreme leverage caused financial crises since the 1930s. “In 24, or 75% of these cases austerity was required, which McKinsey defines as a multi-year and sustained increase in the saving rate. Public and/or private borrowers took on too much debt because they lived beyond their means, or they consumed more than they earned. Thus, to reverse the problem spending had to be held below income, increasing the saving rate.”

But having a solution and executing it are two distinctly different concepts. In the first place, many of our political leaders, in fact most, have a mindset that debt is just another tool for spending or staying in office. It is crystal clear that they will refuse to embrace a voluntary course of austerity. We need only look at their failures in the last few months to find any agreement whatsoever on a solution. Standard and Poor’s has already recognized the disfunction  by downgrading US debt (translated the US is a step closer to the “bang point, ” in the considered opinion of credit experts). They will likely issue another again soon.

In the second place, it is a stretch indeed to expect the average American voter to elect leaders who promise to cut his benefits and who ask him to defer into the future gratification from his labors today.

Americans came together, they sacrificed, scrimped and saved during WWII because they recognized freedom was a stake. Today’s threat is no less acute, but it’s just not as tangible. There’s no Hitler or Pearl Harbor to fortify our resolve. And to make matters worse, adding to our debt seems the most expedient because it ‘buys’ the things that mask our troubles a little longer.

In short, this country needs selfless visionary leaders who are capable of characterizing America’s greatest enemy since WWII and of steeling our commitment to a voluntary season of austerity that could span election cycles. We defeated the tyrannies of King George, Slavery, Hitler, and Imperial Japan. Question is, will we defeat the greatest in our time, Slavery to Debt?