November 23, 2010
Debt and the economy
Turning to the broader economy, another of Davis’ long-term themes is that excessive debt saps economic growth. He noted that debt as a percentage of the GDP was relatively low and flat during the 1960s, 1970s, and 1980s. In the mid-1990s debt really took off and exploded, he said.
Davis also showed a chart of nominal GDP, which he said was much like a mirror image of the one above. “The more debt we have, the more principal we have to pay back, and the more interest we have to service,” he said. “It just sucks the life out of the economy, and it also sucks the life out of inflation.”
Davis has calculated the amount of debt required to produce each dollar of GDP. Over the last 60 years, that ratio grew steadily, most dramatically in the last 10 years. Over the last decade, it took almost $6 of debt accumulation to produce $1 of GDP, Davis said, nearly doubling the ratio of the previous 10 years. “To me, that is excessive strain.”
Over the last 30 years, Davis said, government spending has averaged 21.5% of our economy and nominal GDP growth has been 5.8%. The prior 30 years government spending was only 18%, and yet nominal GDP grew 8%. “So it seems like to me we are not really getting our dollars’ worth for the spending we are doing,” he said. Currently, he added, government spending is nearly 25% – an all-time record.
Davis acknowledged that commodity prices have been rising sharply – some of which is driven by Asia – but he does not believe inflation is a threat. Capacity utilization, he noted, is still very low, which will dampen any prospective inflation.
It’s all about income
“The economy is all about income,” Davis said, because excess disposable personal income drives consumer spending.
A measure known as “tangible assets” – basically, housing as a percentage of disposable income – has now reverted to its pre-housing bubble levels. Housing prices may go a little lower, Davis said, but for the most part they have stabilized.
Financial assets, as reflected in equity holdings relative to income, have gone through two bubbles, in 2000 and 2007. Davis said they are now “reasonable based on income.”
Household net worth has not stabilized in the same way as tangible or financial assets, Davis said. Household debt relative to income is still historically high across the economy, although he said the Fed’s zero-interest rate policy is keeping that debt “manageable.”
Nonetheless, Davis said further deleveraging will be necessary to eliminate excess debt and provide the basis for robust economic growth. “It has to be written off, defaulted, or refinanced,” he said. “We’ve got to get that bubble of debt down to where it is in line with incomes.”
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