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We’re doomed! Even if the economy were growing at a faster pace, it wouldn’t
come close to offsetting the interest payments on our ever-expanding debt. [As such,] any sort of credit shock – either rising rates or a decline in the rate of debt expansion – will cause the system to implode. [Let me explain why that is the case.]
The above introductory comments are edited excerpts from an article* by Charles Hugh Smith (charleshughsmith.blogspot.ca) entitled Why We’re Doomed: Interest and Debt.
The following article is presented courtesy of Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!) and has been edited, abridged and/or reformatted (some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. This paragraph must be included in any article re-posting to avoid copyright infringement.
Smith goes on to say in further edited excerpts:
Total U.S. Credit Market Debt vs. GDP – A Growing Gap
It’s easy to see what’s happening with debt and the real economy (as measured by GDP, gross domestic product): debt is skyrocketing while real growth is stagnant. Put another way–we have to create a ton of debt to get a pound of growth. There is no other way to interpret the chart below.
source: Acting Man
10-Year Treasury Constant Maturity Rate At Historic Lows
The Status Quo has only survived this crushing expansion of debt by dropping interest rates to historic lows. Below is a chart of the yield on the 10-year Treasury bond, which reflects the extraordinary decline in interest rates over the past two decades.
The Federal Reserve has pegged rates at essentially 0% for years. That means the strategy of lowering interest rates to enable more debt has run out of oxygen: rates can’t drop any lower, and so they can either stay at current levels or rise.
Finance Rate On Consumer Installment Loans Declining
Near-zero interest rates for banks borrowing from the Fed doesn’t mean conventional borrowers get near-zero rates: auto loans are around 4%, credit cards are still typically 16% to 25%, garden-variety student loans are around 8% and conventional mortgages are about 4.25% to 4.5% for 30-year fixed-rate home loans.
This decline in interest rates means households can borrow more money while paying the same amount in interest so:
- the interest payment on a $30,000 car today is actually less than the payment on a $15,000 auto loan back in 2000 and
- the monthly payment on a $400,000 home mortgage is roughly the same as the payment at much higher rates on a $200,000 home loan 15 years ago.
source: The Born Again Debtor
Total Credit Market Breakdown By Segment
Dropping the interest rates has enabled a broad-based expansion of debt across the entire economy. Notice how debt has exploded higher in every segment of the economy: household, finance, government, business.
source: The Born Again Debtor
Real Median Household Income
The other half of the debt/interest rate equation is household income: if income is stagnant and declining, the household cannot afford to take on more debt and pay more interest. With real (adjusted for inflation) household income declining for all but the top 10%, households cannot take on more debt unless rates drop significantly. Now that rates are at historic lows, there is no more room to lower rates further to enable more debt. That gambit has run its course.
Many financial pundits claim private debts can simply be transferred to the government and the problem goes away. Unfortunately, they’re dead-wrong. As economist Michael Pettis explains:
“Remember that the only way debt can be resolved is by assigning the losses, either during the period in which the losses occurred or during the subsequent amortization period. There is no other way to “resolve” bad debt – the loss must be assigned, today or tomorrow, to some sector of the economy. “Socializing” the debt, or transferring the debt from one entity to another, does not change this.”
In other words, when marginal borrowers – households, students, businesses, local government agencies, etc.- start defaulting, the losses will have to be taken by somebody…The idea that we can transfer the debt to the government or central bank and the losses magically vanish is simply wrong.
- Even if you drop interest rates, if debt keeps soaring the interest soon becomes crushing.
- Even at historically low rates, the interest on Federal debt will soon double. That means some other spending must be cut or taxes must be increased to pay the higher interest costs. Either action reduces spending and thus growth.
- If rates actually normalize, i.e. rise back toward historic norms, interest payments could triple.
source: Federal Spending by the Numbers, 2013: Government Spending Trends in Graphics, Tables, and Key Points
Understanding how reliance on ever-expanding debt hollows out the economy
- Say the average interest on the $60 trillion in total debt is 4%…That comes to $2.4 trillion annually.
- Now take the $16 trillion U.S. economy and reckon that real growth in gross domestic product (GDP)…is about 1.5% annually. That’s an increase of $240 billion annually.
- That means we’re eating over $2 trillion every year of our real wealth, i.e. our seed corn, to support an ever-increasing mountain of debt. That is not sustainable.
- Even if the economy were growing at a faster pace, it wouldn’t come close to offsetting the interest payments on our ever-expanding debt.
- This leaves the entire Status Quo increasingly vulnerable to any sort of credit shock; either rising rates or a decline in the rate of debt expansion will cause the system to implode.
Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.
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all good points about credit growth in the is country. no question it takes much more debt today to create one unit of growth. I really think you need to refer to japan and their interest rate reduction policy over the last five years!. I believe the fed has much more room to cut rates. why not drop the 10 year to 1.5%. 30 year paper 2.00%. the shock to the economy you talk about comes about from our overall debt is mostly short term paper! because we have so much debt lenders will not lend long. look for 30 year, fixed rate mortgage money to disappear!