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Peak Debt - US Debt & GDP Growth

Economics / Analysis & Strategy Dec 18, 2006 - 11:14 PM GMT

By: Jas_Jain

Economics I am no expert on Peak Oil, but Peak Oil is not the urgent problem that the world faces, economically, or politically. The problems of the supply-demand of oil will play out over a longer period and its effects would be spread over a longer period of time than that of the Peak Debt, which are lot more immediate. As a matter of fact, it has been the rapidly rising debt (racing towards the peak), which in turn has "fueled" a worldwide construction boom, that has resulted in the high prices for oil over the past 4 years and not the realization of the problem of Peak Oil. During the coming global depression, within this decade, the price of crude oil should fall below $25 a barrel and there will be glut due to sharply falling demand. I realize that these are not the concerns that people have today as long as the American consumer keeps borrowing. But, for how long?

What Is Peak Debt?
I will limit the discussion to the US. If one looks at the long-term graph of Total Debt as a percent of the GDP (see graph in the above reference) one sees a Longwave Cycle type of behavior whereby the debt grows for a long period, decades, reaches a crescendo and then seems to fall down rapidly, in a crash-like fashion, and remains low for a long period. Since the process is cyclical in nature, it repeats. Thus, Peak Debt, unlike Peak Oil, is not a theory but an observed reality of our economic system.

What happens at the Peak Debt is that the Total Debt of the economy, as a percent of the GDP, or nominal debt in current dollars, or both, stop going up and start to go down. The last time that the Peak Debt occurred in the US was in early 1930s and I can confidently predict that the next Peak Debt will occur within this decade, because the forces pushing debt higher and higher are reaching a point of exhaustion. The rising Consumption Debt exerts a depressionary effect on future consumption and at some point the debt service reaches a high enough portion of the income that the current consumption must be cut down.

Debt plays an extremely important role in our economic system, especially, if one recognizes that stock market is a substitute debt market. In particular, Consumption Debt, taken on by the households for the express purposes of consumption expenditures (including mortgage debt), plays direct role in income and wealth inequality; high corporate profits, hence stock market booms; inflation rate; etc. All these - inequality, historically high corporate profits, and inflation - peak before the Peak Debt. Peak Debt occurs during the early part of the Deflationary Depression phase of the Longwave Cycle. What follows Peak Debt is a long period of depression, as the material and psychological effects of the prior consumption boom linger. All the above are based on cause and effect and not some theory and fully supported by history of earlier episodes. Since these cycles are rooted in human behavior, in this case the predictable behavior of various participants, especially, bankers and consumers, the cycle unfolds in a "clock-work" fashion.

The modern history of Consumption Debt, on a broad scale, especially, on non-essential purchases, is only a century old. Its messiah was none other than Henry Ford. Ford realized that it is not enough to offer great products at a reasonable price but the consumers must be induced to purchase in order for the producers to be able to sell more and more product and make more profits. This led to financing of the consumer goods that ultimately resulted in the 1920s boom in the US (very very similar to what has been going on in India over the past ten years). What is new in 2000s, compared with the 1920s, is not just pushing the consumer products, for which financing became a vehicle, but pushing of the debt itself, which now results in later afterthought purchases of big-ticket consumer items. I hope that you discern the difference between the two. PUSHING DEBT HAS BECOME THE EASIEST AND THE MOST PROFITABLE BUSINESS IN THE US OVER THE PAST FEW YEARS. Who wants to take the risks of a producer when financing has become so lucrative? Look at the largest "industrial" corporations in the US over the past decade, or two, and what you see is that they are lot more into financing business than in production business.

BTW, the boom-bust nature of the Longwave Cycle has most to do with debt, hence the "banker's mischief" in creating them. Let me quote my favorite economist, Joseph Schumpeter, "One of the results of our historical sketch will, in fact, be that the failure of the banking community to function in the way required by the structure of the capitalistic machine account for most of the events which the majority of the observers would call "catastrophe."" I am amazed by the fact that blind faithful of the American System don't see the current "reckless mortgage lending" as an indictment of the whole econo-political system as being corrupt. These blind faithful will pay the price in not too distant a future. That is what happens with any blind faith. No system, or human institution, is immune from the control by the Crooks. We can proudly claim to be #1 when it comes to takeover of the econo-political system by Corporate Crooks, or as "the Money Bags" had done in England a hundred years ago.

The two largest bubbles of their kind in the US history - the Stock Market Bubble of late 1990s and the Housing Bubble of 2002-06 - over the past ten years are a result of the largest Debt Bubble (or Credit Bubble) in US history.

Economic Central Planning, the American Style
We all know that the Central Planning, the Soviet Style, consisted of planning of the production. In America, Federal Reserve, particularly in the recent years, has been attempting to plan the level of consumption (we all know that the consumption is some 70% of the GDP and to keep the GDP growing consumption must not be allowed to fall below a certain level). The control mechanism is Consumption Debt, because at the margin all the growth in recent years is a result of debt-driven consumption. Thus, by the control of interest rates and lending policies the Federal Reserve affects the growth in Consumption Debt, the most visible examples of this have been the lending on homes and automobiles.

Of course, Federal Reserve doesn't tell you that it is trying to control Consumption Debt, or control the economy via Consumption Debt, but its policies do exactly that. This is because there are other variables that come into play when Consumption Debt is being affected. The most important of these variables being the inflation rate - all other things being equal, the increase in Consumption Debt leads to increase in inflation rate (simple demand driven inflation) and vice versa. Now, that is in Fed's domain.

Let us see, in 2003, Bernanke wanted to artificially boost the economy in preparation for the Bush re-election in late 2004 and his own future appointment. He had read articles by some self-serving economists in 2002, if it hadn't occurred to him, that low interest rates could boost housing and that may lead the economy out of the recession (it was already out of the recession, but didn't feel like a recovery with the employment falling). So, during the first half of 2003, Bernanke, as a Fed Governor, started to publicly talk about the deflation threat and how the Fed can always stop that by "printing money." Thus, the Fed, under Greenspan chairmanship back then, lowered the rates to "emergency" levels when the only real emergency was the Bush re-election. Greenspan was very happy to play along because his own reappointment in 2004 was contingent upon the economy visibly recovering.

The artificially low rates gave rise to artificial boost to the economy in the form of the predictable housing boom, but no one could have predicted the Housing Bubble and the overbuilding that ensued. As mentioned earlier, the global building boom, as well as the general rise in consumption due to the boom, also gave rise to the steep increases in the price of oil, which has led to the current problem of inflation. So, now the Fed has the excuse to force consumption down by altering the availability of Consumption Debt in the form of mortgage refinancing. Therefore, the Fed is actively engaged in leading to the Peak Debt that I am predicting. This is because curbing consumption is necessary to control inflation, especially, inflationary psychology, and it is not an accident that "inflation peaks during the first year of a recession," as announced by Ron Insana on CNBC. One way or another (by raising the rates further, if necessary, or holding rates high enough for long enough) Bernanke will have to bring the consumption down by indirectly affecting Consumption Debt. As in the past, at some point Consumption Debt in the US will peak (the debt service to income ratio having reached historical highs), most likely during the next recession, leading to the general condition of the Peak Debt for the current Longwave Cycle.

With great forethought, in 1999, Bernanke, an academic getting attention as the future Fed Governor, pre-empted any talk of Fed having to take any actions to nip in the bud any asset bubble by his public declaration that Fed should keep its hands off any asset bubbles, i.e., let the asset bubbles build as far as they go. Bernanke was just the man that Bush needed on the Fed for his re-election bid and was thus appointed just in time. (On a historical note, one of the three conditions that Grant had to agree to get the command of the Union Army was that Lincoln be re-elected; this was confirmed by another general who was offered the command on the same conditions, before Grant was offered, and who declined due to the conditions).

Consequences of Peak Debt
The most immediate impact of the falling debt would be a collapse in corporate profits, hence, a sharp fall in the stock market, either crash-like, or over a period of 1-2 years. The second would be fall in inflation rate to level significantly below the level preceding the Peak Debt. Demand Destruction is what is going to kill inflation in the US, as has been the case in the past time after time, and when inflation starts to fall it doesn't stop readily and keeps falling all the way into the next economic recovery. You can count on the inflation rate going down below zero because the rate wouldn't be very high to begin with when it starts to fall. Trying to control inflation rate within a very narrow band, e.g., 1-2% core CPI, is idiotic and tells you more about the mindset of the economic central planers of the US of A than about anything else. Trying to control the economy too finely, requiring too much meddling into the economy, is not a sign of a country committed to free markets. Higher degree of uncertainty is one price of freedom. Control freaks are never lovers of freedom and the Federal Reserve System is a dark mark against the free market principles. In case you haven't noticed, Federal Reserve interferes is the markets, incessantly. These meddlers don't even know the meaning of hands off policy most of the time (to a blind faithful whatever the Fed does must be right and for the good). In attempting to control inflation within a very tight range haven't these geniuses looked at the historical data on inflation? Oh, they are smarter than all the rest in the past?

One consequence of the rise in Consumption Debt over an extended period, mostly pushed on the middle class, is rising ineqaility. This is one consequence that takes a very long time to correct. If you listen to people like Greenspan and Bernanke, who act as if they are "very concerned" about the problem of rising inequality, which they have contributed the most to!, you will hear lame excuses like education gap. What a crock. Is the education gap in the US much higher today than in 1973? Most importantly, the rich are NOT the most educated; it so happens that the most educated serve the richest, who happen to be lot less educated then them! BTW, Bush administration's solution to narrowing the inequality is, you guessed it, "No Child Should be Left Behind" program! I heard an administration official claim that, just a few days ago.

You will find direct correlation between the increase in debt on the middle class, as percent of income, and the rise in inequality. And this correlation is a result of causation. This time, the banking Crooks have taken the problem to such a scale that the middle class in America will be decimated. America will become a nation full of bankrupt households most of whom were formerly middle class. It does not bode well for the stability of the whole political system. The current Peak Debt may well foreshadow the collapse of the American political system, as the world has known it since 1776. And that would be a long life for a political system. Circa 2020s: It was a good system for most of the time it lived. May it rest in peace.

Jas Jain, Ph.D.
the Prophet of Doom and Gloom

© 2005-2017 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


01 Aug 08, 18:56
Peak Oil

Peak Oil is not a theory any more either. The US reached peak oil in 1970. Planet earth reach peak oil in 2005. These are symptoms of a core problem.

The core problem is not peak oil or peak debt. The core problem is the flawed economic policy we embrace in this country known as exponential growth. The other problems, although serious, are only symptoms of this core problem.

07 Aug 08, 18:59
Where to then?

So if this is to be our future, what is the best way to financially prepare ourselves for it? What postion can a savy investor take to best weather this storm?

10 Aug 08, 20:17
Little doubt

That's one of the best pieces of analysis I've seen.

The end result looks like this:

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