Thursday, September 29, 2011

Why Our Debt levels Are So Troubling

The U.S. has huge, growing and unsustainable levels of actual government debt and more than that in unfunded entitlement commitments. That's widely known.

U.S. citizens also have historically high levels of individual and household debt as well. That's pretty well understood, too.

When the public and private debt levels are taken as a whole, we have a serious long term problem which will take years to address successfully. Of course, we haven't yet begun to come to grips with this complex set of issues. Neither are we likely to face them squarely anytime soon.

All that said, perhaps the least understood piece of our overall debt problem is its fundamental nature. Generally speaking, debt is often undertaken to finance investment. In our case, however, that wasn't what happened. The new debt wasn't used for investment purposes, either in the non-government or government sectors. We "consumed" it instead.

In other words, corporations did not assume extraordinary levels of debt to invest in productive assets that would provide future paybacks. Neither did individuals, households or small businesses.

To the contrary, much was "consumed" in such things as residential housing and similar non-productive construction endeavors.

Debt Levels Alone Don't Tell the Whole Story looks at eight European countries and their ascending government and non-government combined debt levels over time. The lesson to be learned for us can be succinctly stated as follows:

"The differences highlight the fact that debt numbers alone tell little. For a country, the ability of the economy to generate growth and profit, and thus tax revenue, is more important. For the private sector, it matters greatly what the debt was used to finance. If it created valuable assets that will bring in future income, it may be good. Even if the borrowed money went to support consumption, it may still be fine if the borrowers have ample income to repay the debt.

That is one reason many euro zone countries are struggling even with harsh programs to slash government spending. With unemployment high and growth low — or nonexistent — it is not easy to find the money to reduce debts. And debt-to-G.D.P. ratios will rise when economies shrink, even if the government is not borrowing more money."

As the article reasons, what the debt is used to finance matters most. In our case, much of that homeowner and non-government debt went to buy land and put homes and other structures thereon.

Accordingly, that lack of investment in manufacturing or "tradable goods" capability will not serve as a foundation for future American economic growth. {Number of the Week: Big Cuts in Manufacturing Capacity}

In a similar vein, growth in government debt was used primarily to support non-productive and non-investment "consumption" spending as well.

As a result, U.S. debt-to-GDP ratios will continue to rise for years to come. We will experience ongoing slow economic growth coupled with high annual deficits. Therefore, barring a political miracle, we should expect that our country's financial condition will continue to weaken.

In the private sector, the deleveraging process will act as an ongoing drag on consumer spending, thus producing subpar economic growth. As that continues, unemployment levels will remain high and tax receipts will remain low.

At some point in the not-too-distant future, we'll have to face facts and make an effort to reduce non-productive and non-value added spending throughout our economy, both as a government and individually.

The good news is that we will have many ripe and wasteful targets when we begin that process in earnest. But first we have to start, of course.

Thanks. Bob.

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