Alan McQuaid, Senior Economic Analyst at Bloxham Stockbrokers, looks ahead to what might happen to US economic policy when the money finally runs out
It looks like US policymakers may finally have reached the end of the road, or at least a major roadblock, in their ability to get households to take on more leverage.
The US consumer debt overshoot in the past decade was far in excess of anything we had seen before, and it was based on very misguided assumptions about the future path of house prices. The hangover from the housing boom and bust will be long lasting in terms of banks’ willingness to lend and consumers’ willingness to borrow. On the surface it is hard to see how the United States can borrow and spend its way out of a crisis that was caused by too much borrowing and spending in the first place. But, that’s what the Debt Super-cycle (the long-term decline in balance sheet liquidity and rise in indebtedness during the post-WWII period) process has always been about, and things will only change when the limits of borrowing have been fully exhausted. And there is one final act left to go in this long-running saga.
If consumers are no longer willing to borrow and spend at a level that guarantees decent growth, then governments have shown that they will do it on their behalf. As a result, the major economies are in the midst of an unprecedented peacetime surge in government deficits and debt. In other words, there is a transition from rapidly-expanding private debt, to rapidly-expanding public debt. The private sector’s ability to carry rising loads is limited by its income.
In theory, the public sector is less constrained because it has the power to generate taxes, and is less prone to going bankrupt than borrowers in the private sector. However, in practice, the financial markets will act as disciplinarians when they perceive that public debt trends are headed out of control. For the US, a fiscally-related financial market crisis should be several years away given that government debt servicing costs are currently less than 8% of total spending. To put that into perspective, when Canada faced the debt wall in the first half of the 1990s, debt servicing costs exceeded 20% of spending. But the fact remains that major fiscal restraint will be needed in the years ahead if the United States, the UK and many other economies are to avoid a crisis.
It is also the case that government borrowing and spending can provide only a partial offset to restraint in the private sector. If we are right that the private sector Debt Super-cycle is exhausted, then it implies weaker than normal economic growth in the developed economies during the next few years. The situation in the emerging world is quite different. It has taken decades of building imbalances and excesses to get the US and several other advanced economies into their current financially debilitated state. In contrast, the emerging world is in a very different stage in its development. Consumer and business debt loads are low because credit infrastructure has been generally undeveloped, and weak or non-existent property ownership rights prevented the development of mortgage markets. Also, many countries suffered external financing crises in the 1980s and 1990s, requiring them to strengthen their balance sheets.
Finally, savings are high because of limited investment opportunities, and the need to set aside money for education, health and pensions. The solution is obvious. While Western consumers concentrate on rebuilding financial health, those in the healthier Asian emerging economies can become more oriented toward borrowing and spending. Such a shift would go a long way to encouraging a much-needed transition in the world economy. The US needs to spend less and save more, while Asia, especially China, needs to do the opposite.
All in all, it is now widely accepted that we are in the midst of a gradual shift in global economic power toward Asia and certain other emerging countries. As part of that process, Asia should become more oriented toward domestic demand, and less dependent on exports to the West. And that is unlikely to occur without Asian consumers becoming more Western in their use of credit.
Debt is not evil as it is necessary to have freely available credit in a modern functioning economy. Few people can afford to buy homes and cars for cash, and companies need access to credit in order to finance investment and inventories. Of course, credit does get abused, and it is up to financial regulators to minimise the dangers, a task in which they failed miserably all across the globe in the past decade.