TMFDeej (99.47)

Reducing debt won't be fun, but it's the only way out of this mess

September 08, 2009 – Comments (7)

Everyone and their mother has been talking about how the U.S. consumer is in debt up to their eyeballs and that the savings rate in the United States had fallen to an unsustainably low level.  Well it appears as though this is in the process of changing my friends...at least on the consumer side.

consumers cut debt by record $21.6B in July

In July, consumers slashed their borrowing by the largest amount on record.  The Fed reported this afternoon that consumer credit fell by $21.6 billion from the prior month in July.  This is the largest drop on record, which dates back to 1943.  So much for that $4 billion drop estimate that those fancy economists came out with.

Demand for non-revolving credit, i.e mortgages, auto loans, etc..., fell at an 11.7% pace, after sliding by 8% in June.  Revolving credit, aka credit cards, dropped by 8% after falling 6.4% in June.

This is bad news for an economy that is based upon ravenous consumer consumption, but in the long run I believe that consumers getting themselves out of debt it a good thing.  What do those who are complaining about the drop want to happen, for us to continue perpetuating an unsustainable debt cycle for even longer?

For now, Uncle Sam is desperately trying to make up for this lack of consumer borrowing...and in turn spending, but racking up a slug of debt of its own.  I'm not fan of massive budget deficits, in fact I hate them, but perhaps this spending will help ease the pain some.  Time will tell.  For now, some idiots out there are willing to lend the U S of A money for ten years at measly three and a half percent interest.  If I was the government, I would be loading up on as much of this low cost money as possible for as long as possible before interest rates head higher...which they inevitably will.

My main problem with government spending is that, much like any large organization such as General Motors, AIG or a myriad of other big companies, the government is inefficient and filled with waste and corruption.  If the government was able to spend money efficiently borrowing it at this rate would be a no-brainer.  Alas, that is not the case and ultimately taxes will have to head higher in order to pay off this debt, which will act as an anchor that the economy will have to drag in order to grow going forward. 

Add higher taxes and an aging population to a host of other economic problems and economic growth will almost certainly be slower over the next twenty years than it was over the past two decades.  Of this I have little doubt. 

Having said this, there is a huge difference between having much slower economic growth over the next several decades and the United States falling into a chaotic, Mad-Max like world that's filled with zombies like some people seem to be rooting to happen.

Let's think about some cause and effect here.  What is the most likely result if the trends that I just mentioned, reduced consumer borrowing and increased government borrowing, continue for some time to come.  Consumers put their balance sheets in much better shape.  That's a good thing.  The government's balance sheet looks much worse.  That's a bad thing...but it has an interesting side effect.

The continued racking up of debt by Uncle Sam would likely cause the value of the U.S. dollar to deteriorate.  I still am of the opinion that any deterioration will be fairly orderly, rather than a complete implosion.  Many other major countries have much, much higher debt to GDP rations than the United States has right now, such as Japan, the UK, etc... and their currencies haven't completely imploded in a Zimbabweian manner.  Why would ours? 

So the value of the dollar continues to fall at an orderly pace, perhaps more quickly than many (including myself) would like, but not a complete implosion.  Such an event would make things more expensive here.  That's bad.  However, a drop in the value of the U.S. dollar would have some positive side effects as well.

1) A lower dollar would make our exports much more attractive to other countries.  China is in the dominant position that it's in right now in large part because it kept its currency so low and it was able to export its cheap goods all over the world.  I realize that this is a foreign concept in our current service-based economy where everyone is either a financial advisor, a lawyer, etc... but what if America eventually became a place where stuff could be manufactured cheaply?  We would keep jobs at home rather than shipping them abroad.  Tax revenue would increase.  The trade deficit would fall.  Good things.

2) A lower dollar would make it much easier for the government to pay back its bloated debt.

Things change.  The adjustment period won't be fun after years of partying like it was 1999 with abnormal economic growth, but that doesn't mean that our way of life is coming to an end.

Deej