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Yawning Debt Trap Proves the Great Recession is Still On

Published in the US before 1923 and public domain in the US. Used to represent people piling up America's national debt.

While David Stockman stated early this year with resolute certainty that the debt ceiling debate would blow congress up and send the nation reeling over the financial precipice, I avoided jumping on the debt-ceiling bandwagon. While I was convinced major rifts in the economy would start to show up in the summer, I was not convinced they would have anything to do with the debt ceiling debate. If there is anything you can be certain of this in endless recovery-mode economy, it is that the US will just keep pushing its bags of bonds up a hill until it can finally push no more. So, I figured another punt down the road was more likely.

 

The Debt Ceiling Debate that Didn’t Happen

 

The reason I didn’t think that debate would blow apart is that Republicans have more than once experienced the political reality that comes from taking the nation to the brink of default or of shutting down government. Each time that kind of thing has happened, it has hurt Republicans far more than it has hurt Democrats. I doubted establishment Repubs (the majority) had the stomach to take us through another credit downgrade, though I’ve noted such an event was possible.

Unsurprisingly to me, then, Congress did the only thing it seems to be capable of any more and just kicked that can a little further down the road with hardly a kerfuffle about it. Hurricane Harvey made things a lot easier for congress to kick the can again by providing a good excuse to dodge that unwanted debate on the basis of massive human suffering that truly did need tending to. Much-talked-about government shutdown put off for a better time

The debate was entirely avoided even as the national debt broke over the $20 trillion mark this summer, keeping US debt at more than 100% of GDP, which is the stratosphere we’ve been in since 2011.

 

A group of progressive economists affiliated with the University of Massachusetts predicted in 2013 that a debt burden [that reaches 90% of GDP for five years] would result in an annual growth rate of just 2.2 percent, which means economic stagnation. (Reason.com)

 

We’re already well past that five-year marker. Not surprisiing, then, that the Congressional Budgeting Office expects economic growth to stay at 1.8% through 2027.

 

George Will observed that the difference between 2 percent annual growth and 3 percent annual growth is the difference between a positive, forward-looking country in which politics recede from everyday life and a Hobbesian nightmare in which interest groups slug it out over a barely growing pie. Note that he was talking about 2 percent annual growth, which seems positively aspirational in the 21st century. (Reason.com)

 

By James Montgomery Flagg. (Cartoon by James Montgomery Flagg, via [1]) [Public domain], via Wikimedia Commons

Nation caught in a debt trap

 

The biggest (or most likely threat) from the national debt is what economists refer to as a debt trap. The nation can be considered caught in a debt trap if the Federal Reserve loses the ability to raise interest because the rise in interest would immediately drown the economy or cause the nation to default on its debt. So long as interest rates are low, the US government can afford its huge debt; however, we are now at a point where, if interest rates rise to historically normal levels, we’re in big trouble. That means we are in, at least, enough of a debt trap that interest rates can never be allowed to normalize.

Several debt traps are shaping up besides the one formed from government debt. One is the corporate debt trap, where corporations have kept earnings per share high by taking out huge piles of debt year after year to buy back shares. If businesses have to refinance all this debt at a higher interest rate, they could be in big trouble. We hear over and over that today’s high stock valuations are justified by the fact that earnings keep growing; but it is not top-line revenue that is growing, it is earnings per share, and most of that “growth” is due to corporations taking out debt in order to buy back shares and thus reduce the number of shares over which those earnings are divided. If interest rises, corporations will no longer be able to afford to buy back shares on debt, and that support for the market will crash. They might not even be able to afford to pay off the debt they have already taken on. So, there is another reason the Fed can never allow interest to normalize by historic standards.

Yet another debt trap now exists in personal credit where many households have reached peak debt. Household debt maxed out this summer above the level it had hit at the peak of the 2007 credit bubble — one more of those big signs of trouble in the economy that I said we could anticipate seeing by the time summer rolled around.

Income, in the meantime, has not improved in order to support this higher level of debt, now at a level that already proved unsupportable in the past. That puts the US back in the unstable position where households that already carry all the debt they can afford can be suddenly sunk if they have any variable-interest credit cards or an adjustable-rate mortgage. That is yet another reason the Fed can never allow interest rates to normalize.

 

Harvard economist Kenneth Rogoff warns that a sudden spike in interest rates is the biggest threat to the global economy…. People have got used to ultra-low interest rates….  “If something was to happen that pushes interest rates up, we could see a lot of soft spots — places where there is high debt — start to unravel,” Rogoff said. (NewsMax)

 

It should be no surprise, then, that the number of credit-card accounts moving into delinquency swung upward for the third consecutive quarter this summer, a nine-month trend not seen since the bottom of the 2009 crisis. Yet another summertime crack in the economy — one that is not large yet but will become large quickly if the Fed allows interest to move upward any more than it already has.

In short, the national economy is riddled with high debt everywhere, which leaves every area of the economy with little wiggle room. So, the one certain thing about the huge piles of debt that have built up in the last few years is that we have reached the point where they are actually starting to box the Fed in to where raising interest to combat inflation will not be possible because it will cause damage throughout the economy. The tide has already closed in around the Fed to where it can no longer move to normalize interest in any direction without going deeper into rising waters.

S&P’s chief economist, Beth Ann Bovino, wrote recently that “failure to raise the debt limit would likely be more catastrophic to the economy than the 2008 failure of Lehman Brothers and would erase any of the gains of the subsequent recovery.”

 

The Great Recession is still with us

 

If you want to get a sense of how the debt trap affects the nation’s real net worth, consider what the total gross domestic product of the United States looks like if you subtract all that debt that we’ve added each year in order to create that product:

 

US GDP Minus Debt Graph from Federal Reserve

Note: Federal Reserve Economic Data sheets express GDP in billions while Federal Debt is expressed in millions, so in this chart they multiply their data numbers for GDP by 1,000 in order to express both in terms of the number of millions (there being a thousand millions in every billion).

 

That is essentially the debt trap in a snapshot. And that’s just subtracting the federal debt from GDP. What would it look like if we subtracted out all the business debt that was piled up in the creation of our total domestic product and all the personal debt? You can see the picture looked positive right up until the Great Recession hit, and it has deteriorated precipitously ever since.

Based on this picture we have remained in a huge depression since the financial crisis. I have been saying all along that we are still in the Great Recession, which is why I called this blog The Great Recession Blog. The Great Recession still defines our present economy. We never exited; we just propped the economy up (created positive GDP) with mountains of debt (federal and corporate) so that we cannot feel how deep that depression really is; but the debt trap will suck us into this abyss as soon we can no longer sustain the creation of that debt. We have not powered out, as the Fed planned. If we had, GDP would be growing faster than debt.

We are essentially at that point of stark realization now as the Federal Reserve reduces its reinvestment in government debt (bonds) this month. (A process slated to start slow but to become huge by the end of 2018.) Until now, when a government bond matured during this past decade of Fed stimulus so that the government became responsible for repaying the bond principle to the Fed, the government just issued another bond, and the Fed bought that. The new issuance gave the government the money it needed to pay off the first bond. Now that the Fed is backing away from buying new government bonds (starting to divest), the government will be forced to find other financiers.

That will most likely raise the interest the US government has to pay in order to attract new buyers of its bonds, making the national debt less and less sustainable. What happens, then, to GDP as the government finds it harder to maintain its huge deficit spending that is propping up GDP (because the things government buys with that debt have always been included in GDP calculations)?

This unwinding scenario, of course, depends on what happens in the rest of the world because the US doesnt finance all of its debt internally. If Europe, for example, starts to collapse ahead of the US (as it now contemplates its own unwind), the US could once again prove to be the best looking horse in the glue factory and, so, still find ready foreign buyers at low interest for bonds that have to be issued to someone other than the Fed now that the Fed (the buyer of last resort) is backing away from repurchasing. That could purchase the US yet, again, a little more time. (That could just as easily swing the other way, of course, with the US collapsing first, sending money fleeing to Europe.)

Another way to look at our present situation since the Great Recession began — in order to see that its new economy stays with us — can be seen in this chart:

 

 

The trend line in GDP per capita (with government deficit spending still included in the calculation of GDP) broke off at the start of the Great Reession, and it clearly never recovered. It relentlessly sputters along at a decreased rate of growth. Moreover, it has only been maintained at that much lower trend because of the massive amounts of government debt and Fed stimulus. So, what happens to the new trend line when when that money is withdrawn from the economy and interest is allowed to rise?

The bags full of bonds we are pushing up the hill will become significantly heavier if interest rises and will exhaust us, and the present change in Fed repurchasing is a big enough change to tip that balance (given that the amount on the balance sheet the Fed is planning to now unwind is equal to more than 20% of GDP). That is why Jamie Dimon of JPMorgan Chase warned that we’ve never seen anything on the scale of what is about to happen and had better be careful.

One essential truth underlying this blog has always been that you cannot dig your way out of a debt-based financial crash by digging the debt trap deeper and deeper. I called this The Great Recession Blog because I believe the most fundamental truth about our current economy is that we are still in the Great Recession. It broke us for good in that we have not recovered from that event even with massive amounts of stimulus (beyond anything the world has ever attempted).  GDP looks marginally acceptable but only on the surface and is clearly continuously now on a lower trend. Underneath it all is a yawning pit of debt, more than capable of swallowing our entire economy.

 

  • GonzoTheBurner

    So when GDP goes negative, the stock market tanks and businesses and banks start failing due to scandal and debt… will you call it the Great(er) Depression Blog? I like the info Dave, but I gotta say, feels like a depression to me and those around me. Most food items have gone up 25% or more in 2.5 – 3 years. Us blue collar country folk gotta hustle like a hunting dog to get the basics (don’t wanna touch my small lot of investments). I did credit cards for a year, don’t like the taste of owing someone. I’m seeing spirits break out here, gets any harder and I suspect the suicides will take off like a rocket, along with the drugs and drinking. We don’t need a crash, at this pace in another few years, 1/3 of the US will be dumpster diving & camping in the streets.

  • Auldenemy

    Great article! Stockman has been calling for a stock market crash for years, and like the proverbial broken clock he is bound to get it right eventually. Meanwhile the S&P500 has risen like a cake with too much baking soda. Of course in the case of the ever rising S&P500, the baking soda rising agent has been a combination of masses of QE, Operation Twist (oh, how banksters love to employ euphemisms for their acts of trickery), ZIRP and of course the infamous Buy Backs. Add on the PPT making sure any red lights turn back to green and it is not surprising the S&P500 keeps breaking all time highs. Other major nations whose CBs also adopted the baking soda agent have of course had the same same result with their countries stock markets. Unfortunately they are all fake stock market bulls (for the reasons already referred to). When stock markets completely depart from underlying, economic fundamentals we know we are living in countries where by our monetary systems and markets are completely rigged. The problem with that is then a diversion from the mean takes place, in turn creating massive wealth disparity powered by debt. 2008 was the result of Banksterville issuing too much debt and their answer to 2008 has been to create even more. Who has gained since 2008 other than the globalised, bankster lead Corporatocracy who created the financial crash in the first place! In fact 2008 was the defining moment, where surely no one can be in doubt that this parasitical elite is a government legitimised mafia. Instead of nationalising and completely reforming all these corrupt and broken banks, Western politicians bailed them all out, handing its citizens the bill in the form of ever more bloated national debt in turn causing savage cut backs and stagnant wages. CBs went straight to work to inflate stock markets and blow another housing bubble by virtually doing away with interest rates. So house prices are beyond the reach of more and more of the Western population causing more people to rent and now rents sky high in most parts of the developed world.

    David Stockman is a very clever guy and of course worked in the Reagan administration, but the USA of that time and today is as far apart as Mars is from Jupiter. It dawned on me back in 2014/15 that analysts calling for an imminent stock market crash were not properly taking into account the power of the baking soda event on world markets. Many analysts love to refer to the crash of 1987 and the dot com crash of 2001. I don’t see their relevance in a world now consumed by QE, ZIRP and even NIRP (none of which existed prior to 2008). When something changes dramatically it is pointless referring to previous events and coming to the conclusion that things now will follow the same course as they did previously (when those previous events happened in totally different circumstances). This is not me saying there won’t be another financial crash, just that we are now in an Alice In Wonderland monetary policy world and delusion can last a long time!

    As to prognostications made by Jamie Dimon, he is one of the major swamp dwellers, merrily floating on a sea of excrement that he helped to create! Dimon picks up his lottery win salary and bonuses every year from a bank that has a long record of being completely corrupt. Only recently he was bashing BitCoin, which I find completely hypocritical considering his bank is heavily invested in the crypto space (as is Goldman Shysters). So anything the likes of Dimon has to say is not something I tend to believe in. He may be right of course and is airing his, ‘concerns’ now so that when the next crash comes he can gloat and say, ‘I told you so’. Whatever, the guy is a fully signed up member of Club Parasite and far from being the answer to the financial woes of the West he is just part of the problem. The greatest problem of all is that somewhere down the line (probably the creation of the Fed) banksters took over government. We see this clearly in today’s world where one leading politician after another has been bought out by the bankster lead Corporatocracy. This set up isn’t going to end any time soon. There has always been a parasitical elite in one shape or form throughout history and there always will be. They are obsessed with power and wealth and don’t give a rats arse about the rest of us. They don’t have a single moral cell in their bodies.

    For awhile now I have started to think that our parasitical elite are trying to, ‘Manage’ us down into poverty, while at the same time managing their own wealth ever higher. Their problem is that dumbed down as their education system has made us, there will come a point where a growing amount of poor Western citizens go into total rebellion mode (we are already seeing this in Europe with a growing distrust of the EU bureaucratic dictatorship which serves its self before all else).

    I think Banskterville has created fake bull markets to buy itself time. All CBs are wanting cashless societies which is why they haven’t got their government muppets to ban private cryptos (yet). Banksterville is working flat out behind the scenes to invent a crypto platform that can be easily used by the masses. Once it has achieved that then such a system will be forced on the masses and no doubt private cryptos will be banned. Once we are all herded into digital only money our last vestiges of financial freedom will be lost. That I think is the end game our parasitical elite are working towards. In affect they will be swapping one Ponzi scheme backed by nothing (paper money) for another (purely digital). No doubt there will be a great monetary reset down the line, one of course that benefits the parasitical elite while enslaving the rest of us completely.

    Multum In Parvo

    • Hi, Auld. Missed you around here. I tried to post a brief (believe it or not) article yesterday in addition to this one showing how the banksters have profited since the Great Recession while everyone not in the top ten percent has lost, but my internet access crashed just as I was posting it. I’ll see if I can recover it.

      • Auldenemy

        I always look out for your latest articles. The reason I haven’t left comments is due to illness since August (and Meds for it creating another infection which I can’t seem to get rid of).

        I agree with all you say and of course you are right to include comments made by Dimon, or any other top bankster. I didn’t mean my views on him to come across as criticism of you quoting him in your article. I just think it is now vital that when analysts mention any senior bankster that it should come with a warning (LOL). I despise the likes of Dimon so much that I am unable to respond to anything about him without also pointing out that he is one of the major swamp dwellers.

        You are spot on about the utter BS of, ‘Trickle down wealth’. It hasn’t trickled down has it! The parasitical elites, whether banksters, politicians or big corp. chiefs squirrel their ill gotten gains away. If they didn’t there wouldn’t be events like the Panama Papers leaking out. There must be endless billions of dollars, euros, pounds etc out there doing absolutely nothing (just rotting in off shore accounts). I find it incredible that Trump’s tax proposals will mainly assist the already obscenely rich (as if they haven’t looted us all enough post 2008). I don’t think the average American would ever vote for that (they vote for the con that such tax cuts will somehow improve their lives). As you say, greed is blind to the consequences of greed. The bottom line is that if this madness continues there will come a day of reckoning. When enough Western citizens enter the gates of poverty there will be out right rebellion against Club Parasite. There is only so much hypocrisy people can take, especially when they can’t afford to even rent a home, keep it warm and feed their children properly. The West isn’t there yet but more and more of us are struggling to get by while at the same time having to watch the parasitical elites take more and more of the pie.

        • Sorry to hear about the run of hard luck, Auld Friend. I hope the winter brings recovery and better times. (I’ve been the route, myself, where the antibiotics created a far, far worse infection than the one that caused me to take the antibiotics in the first place.) Lost forty pounds that I didn’t have to lose before they finally got it routed.

          Have no concern about the comments on Dimon. I didn’t take it as criticism, but just took the opportunity to explain why I quote him once in awhile. It’s one of those things where, when even the dark side of Wall Street says troubles could be imminent in the stock market, you have to think one of two things: either 1) the troubles are becoming so likely that the big guys are starting to cover their arses by admitting troubles are coming or 2) he decided to take the other side of the bet from usual.

  • Jack

    Nice summation. BTW, ZeroHedge brought me here.

    Two points for consideration:

    1. Pensions: Ultra low interest rates have caused the Defined Benefit (DB) pension plans to START to adjust asset return assumptions. They are just starting. If you are right then they have a long way to go and this will probably lead to significant distress in older corporate names with DB plans. It will also lead to much greater distress in local and state governments who’s pension accounting (GASB vs FASB) is complete garbage and massively understates their liabilities and overstates their assets (much more than FASB does – which doesn’t do a great job either). Since a lot of these obligations are inflation linked, this situation will become significantly worse if inflation breaks out and the Fed can’t react. Look for and state governments to try to put this liability back to the federal government on the basis of the (somewhat correct) argument that the Fed did this.

    2. The Fed Itself: Let’s not forget that the Fed itself has a huge balance sheet of long dated Treasuries and Agency MBS. If rates where to rise then that portfolio would loose a lot of its value. I know that the Fed does not mark to market, so they will never show a “loss” from any such move, but they will still have a loss that will have to be paid over time with negative carry. Accordingly, the Fed is going to need the Federal government to fund that negative carry. This is going to lead to an interesting dynamic where the Fed, which I believe for the first time, will be asking the Federal government for money at the same time that Federal government is under the stress that you discussed above. This should make for an interesting Humphrey-Hawkins testimony session.

    • Auldenemy

      The Fed is in the luxurious position of having its cake and getting to eat it! It is a private entity, made up bankster share holders so immune in many respects from government interference (like being required to have an independent audit!). JFK knew the Fed was a case of the tail wagging the dog which is why he stopped the Fed from issuing dollars and handed it over to the Treasury (as in under government control, where national money is supposed to be!). So for a short period the USA had dollars that were Treasury, not Fed, notes. That all ended when JFK was assassinated, and the Fed went back to issuing the currency. The Fed can’t ever go bankrupt because it can always invent money out of then air (QE being an example of that). Who initiated QE? I didn’t see Congress debating it and approving it (the same with all other nations who adopted it). CBs are really a power unto themselves (yes, the President gets to appoint the Fed governor but that’s just window dressing to fool the public into thinking the Fed is a democratic structure under government control. It isn’t!). I don’t see a scenario where by the Fed will ever need to ask the Federal government for anything! It is the other way around, our governments are only too happy for our CBs to invent money which then ends up becoming a national debt liability (it is never the liability of either Central or private banks

      • Aye. That’s really the sum of it. The Fed will print its way out of any obligations it has. Since they have been making up most of the rules as they go, they will do what they need to do. Frankly, I’m not sure why they even think they have to reduce their balance sheet — other than they are used to thinking of themselves as running a smaller balance sheet. It’s not causing inflation anywhere other than stocks. (I mean, I don’t know why they think they have to from the perspective of their own objectives and their own ways of measuring those objectives.)

        Nevertheless, they have decided they need to normalize, and they seem to believe they actually can. They will find they cannot. They have created markets that are utter dependent upon the drug they have been administering.