A Nation's Individual and Household Debts Need to be Combined with Government Debts to Know The Real Story

There has been much talk recently about the dangerous debt levels of various governments, including the U.S. and many European countries.

That said, government debt is only part of the story, and frequently not the most important part.

So let's add the private part of the indebtedness story which concerns individual and household related debt.

First, let's state the obvious. To wit, individual taxpayers and individual household consumers consist of the exact same people. Accordingly, these people are the sole source of those repayment funds necessary to pay both the interest and principal on outstanding debt, whether publicly or privately initiated.

As these required debt service payments are made, current consumption suffers. Stated another way, consumer spending will be lower than it would have been but for the increased taxation and added individual debt service requirements.

As a result, the economy will remain weaker than it would have been, tax receipts will be lower and job growth will be anemic.

Instead of being available to consumers for discretionary expenditures, payments will be allocated toward either taxes or household debts. Taken together, it's a double whammy to the economy.

To repeat the blindingly obvious, since all debt is debt, it must be considered as a whole when looking at a nation's economy.

And when debt induced inflationary asset bubbles burst in the private sector, that debt remains. Then many lean years will lie ahead for a country's citizens. In that regard, Spain's case is instructive.

Although many U.S. citizens believe that government spending and debt is the sole source of our problems and hence the only critical issue to be resolved, that's simply not the case. Our nation's ongoing financial problems are heavily weighted toward individual and household debt, just like Spain's.

Myth and Reality About the Euro Crisis discusses the effect of cheap money and easy credit on Spain's residential construction boom and its aftershocks when the housing bubble burst:

"So for years, Spain actually had negative real interest rates . . . . That gave Spanish households and businesses a huge incentive to borrow. They did, with gusto, and ploughed the money mostly into housing, inflating a giant property bubble.

When the financing dried up after Lehman collapsed, Spanish banks and households were saddled with a glut of overpriced housing. As Spaniards labor to pay off that debt with ever-shrinking assets, the economy has ground to a halt, and unemployment has soared to 23%."

Spain's Example Shows Limits of EU Targets describes what happens when a debt induced asset bubble finally bursts. Here are some of the article's significant excerpts:

"Leading up to the 2008 financial crisis, it (Spain) was one of few euro-zone countries—Ireland was another one—that complied with the EU's so-called Stability and Growth Pact. Since 1998, Spain's budget deficits came in below the limit of 3% of gross domestic product. {Translation: No burdensome government debt prior to the housing crash.}

The country ran surpluses some years. Government debt stayed below 60% of GDP, and climbed above that threshold only last year. It remains well below the euro zone's average. These achievements were helped by the Spanish government's wish to project fiscal responsibility as well as the boom in its property sector. {Translation: Much healthier government debt numbers than the U.S., both before and after the housing crash.}

But Mr. Cailloux (European economist) says meeting those targets didn't prepare Spain for or fix the problems that had built up in its economy during the housing boom and that became clear after that bubble burst in 2008. {Translation: Government debt wasn't the problem.}

During the boom years, a wave of cheap credit flowed into Spain, feeding the bubble. Soaring household consumption boosted tax receipts and employment. But labor costs and private household debt also rose quickly even as productivity flat-lined or declined. . . . {Translation: Sound familiar?}

Meanwhile, households are trimming debt and buying fewer electronic gadgets and cars. Unemployment has hovered above 20% for nearly two years. Youth unemployment is almost 50%.{Translation: The aftershock.}

Spain's economy grew at a 0.7% annual pace in the third quarter, after contracting in 2009 and 2010. Many expect it to turn negative again. {Recession ahead?}

That may spell trouble, says Simon Tilford, chief economist at the London-based Centre for European Reform. Businesses may be unwilling to invest while the outlook for demand continues to be weak, he says. Government austerity may further lower internal demand, which in turn would weigh on tax receipts and government budgets and debt levels as well as GDP.

Spain relied too heavily on its construction sector to spur growth in the early 2000s, and now "they don't really have a growth strategy," he says. "The only real way out is export-led growth, and it's far from clear how they are going to be able to generate that." He said because European countries buy mostly from each other they cannot all boost exports at the same time."

The public sector debt problem of the U.S. relative to Spain is much larger. On the other hand, unlike Spain, the U.S. economy's health isn't highly dependent on exports. In addition, we not only have our own currency, but the U.S. dollar is the world's reserve currency, too. Finally, our U.S. economy is orders of magnitude larger than Spain's.

So we have lots going for us as a nation. For instance, our relative lack of reliance on export sales is where the U.S. genuinely stands apart from other countries. We simply don't require extensive exports to have a strong economy.

That said, added domestic energy production when combined with more energy exports will make our economy very strong again. As we produce more of our own energy needs, we will become more energy independent and enjoy a stronger domestic economy as well. As a result, we will become even less reliant on export sales.

Now all we need to accomplish this magnificent trifecta is for the political gamesmanship to cease.

Now let's recap.

(1) In contrast to the U.S., European and Asian nations as a whole rely heavily on export sales for economic growth.

(2) Spain is an illustrative example of what happens when a nation and its citizens take on too much cheap and readily available residential housing related debt.

(3) If in the future, we again undertake unsustainably onerous household debt obligations in order to build and buy homes and other related assets, we will experience another precipitous decline in the value of those assets.

(4) The fundamental point is that government debt is only one piece, albeit a most important piece, of a society's overall debt obligations. The household debts of citizens are also critical components of that debt picture.

(5) When combined, the debts of a big spending government and an overstretched household sector will create a dangerous financial condition, after which many lean years will follow.

(6) That's because after the asset bubble bursts, which it inevitably will, there will be no easy or quick way to repay the loans attached to the depreciated assets. And to add insult to injury, lenders won't be eager to extend or roll over outstanding loans. Then defaults will occur and bankruptcies will result.

(7) Finally, harsh austerity measures will necessarily be implemented, and the economy and unemployment will become even worse.

Obviously, it's best not to let any this happen in the first place. In that regard, we need to pass along to those who follow the many valuable and terribly costly lessons we've discussed herein.

Thanks. Bob.