Yesterday’s good news was that there will be no 25-year recession. “We should be so lucky,” is the way a New Yorker might react. Because the bad news is much worse.
The logic of the “long depression” is simple. Aging populations, debt, zombification – all of which slow growth.
How many old people and zombies do you need before an economy comes to a halt?
Nobody knows. But the drag from debt is observable and calculable.
Over the last three decades, approximately $33 trillion in excess debt has been contracted – above and beyond the traditional ratio to income – in America alone. And growth rates have fallen in half.
That’s because dollars that would otherwise support current spending are instead used to pay for past spending. Our old debts have to be retired with current income.
The money doesn’t disappear, of course. Some goes to creditors who spend it. Some comes back as capital investment, which is a form of spending. But as credit shrinks, generally, so does the economy.
And that brings us to the impossible situation we’re in now.
In order to get back to a healthy ratio – say approximately $1.50 worth of debt for every $1 in income – you’d need to erase all that excess that has already been contracted. In other words, you’d have to take $1 trillion out of the consumer economy every year for the next 33 years.
It would be the longest and deepest depression in U.S. history.
A Credit Crisis, Complete with Howling, Whining, Finger-Pointing
Take a trillion out of the U.S. economy and you have a 4% decline in GDP. Then, as the economy declines, the remaining debt burden becomes even heavier.
Try to pay down debt and it becomes harder and harder to pay down. You stop buying in order to save money. Your local merchants lose sales. Then they try to cut expenses, and you lose your job.
In other words, no “steady state slump” is possible.
When the credit cycle turns, it will not be a gentle slope, but a catastrophic cliff… a credit crisis, complete with howling, whining, finger-pointing… and more clumsy rescue efforts from the feds.
As we said yesterday, there are two solutions to a debt crisis. Inflation or deflation.
Central banks can cause asset price inflation. But it is not always as easy as it looks. Consumer price inflation requires the willing cooperation of households.
With little borrowing and spending from the household sector, credit remains in the banks and the financial sector. Asset prices soar. Consumer prices barely move.
U.S. consumer price inflation over the last 12 months, for example, was approximately zero.
The assumption behind the “long depression” hypothesis is that central banks cannot or will not be able to cause an acceptable or desirable level of consumer price inflation. As a result, the economy will be stuck with low inflation, low (sometimes negative) growth, and low bond yields.
But what about deflation? If inflation won’t reduce debt, why not let deflation do the job?