May 15, 2012
Global economies are experiencing unsustainable debt disequilibrium, according to Lacy Hunt. Economic textbooks preach that equilibrium, rather than transition, should be the predominant condition. But our attempts to reduce our indebtedness by taking on more – and less productive – debt are weakening our economy and creating unstable conditions.
Hunt is executive vice president of Texas-based Hoisington Investment Management. He spoke on May 3 at the Strategic Investment Conference in San Diego, hosted by John Mauldin and Altegris Investments.
“If we take on debt, either in the private sector or indirectly in the government sector, to finance current consumption, the net result is that we will make the economy weaker and weaker,” Hunt said. “That is basically the path that we are on.”
Hunt cited several econometric studies to illustrate the pernicious effect of debt on economic growth, and he argued that, historically, austerity has been the most common path to recovery.
Hunt provided articulate and thorough support to those who call for deficit reduction through aggressive cuts in government spending. I’ll present an alternative path to economic growth – one which is at odds with some aspects of Hunt’s. But, first, let’s look at what Hunt said.
The enemy of growth
Our debt is historically high, and it’s impairing our growth, according to Hunt.
US private and public debt – excluding entitlements – is now 360% of GDP, Hunt said. High debt levels were reached three times before and, he said, in all cases the economy suffered as a result.
The first was in the 1820s, when we were building roads and canals beyond the Alleghenies. But we paid a price, according to Hunt – a panic in 1838, followed by slow growth until the Civil War.
The second episode was in the 1860s, when we built the transcontinental railways. Hunt said that most of the government-financed railroads subsequently failed, and four decades of slow economic growth ensued.
Hunt’s third example was the debt buildup that began in the 1910s and grew until the debt-to-GDP ratio peaked in 1933. It wasn’t until 2003 that the debt-to-GDP ratio exceeded its 1933 peak.
Hunt faulted the Fed to providing excess liquidity to the market in 1920s and again from the late 1990s through 2006. Since 1998,“We have added 100 points to the total debt-to-GDP ratio and yet our typical family is no better off,” he said. And how are we trying to solve the problem? By either encouraging the household sector to take on more debt mainly for consumption, or having the government sector take it on and subsidize the private sector.”
The eurozone and the United Kingdom have similar challenges, with overall debt-to-GDP ratios of 450% and 470%, respectively, Hunt said.
Japan is the cautionary tale for the US, according to Hunt. In 1989, its debt-to-GDP ratio reached what the US experienced in 2008. Hunt said that, even though the Japanese did everything that Keynes and Friedman would have advised, all that resulted were two lost decades and an increasing level of debt.
Hunt dismissed the possibility that Chinese consumption and economic growth would rescue the global economy. China, in his view, is too is burdened with excess debt, which it has used to fuel investment and consumer spending. But now, Hunt said, “big government loan banks are almost in an insolvent situation.”
After the Fed encouraged the massive buildup of debt from 1998 to 2006, “the monetary or fiscal responses mattered only to a very marginal degree. We had to prevent the problem before it occurred.”
“At that point in time, we had to suffer the consequences,” Hunt said.
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