Friday, February 5, 2021

"The Debt Death Trap"

"The Debt Death Trap"
by Jim Rickards

"This morning we got our first look at what we can expect for the next two years (assuming Joe Biden lasts that long). The Senate voted on Biden’s $1.9 trillion budget resolution last night. The vote broke along partisan lines, ending in a 50-50 stalemate. Republicans had proposed a package that would cost about $600 billion. Vice President Kamala Harris cast the deciding vote at 5:30 this morning, breaking the tie. Harris’s role is key because she’s essentially a 51st senator who will break 50-50 ties in favor of Democrats. You can expect many more of these types of votes.

This morning’s vote allows the legislation to go forward. But that doesn’t mean the process is over. The Senate added amendments to the bill that the House had already passed. For example, Senate Democrats reversed previous Republican provisions that would have supported the Keystone XL pipeline and fracking for oil and natural gas. Cancellation of the Keystone Pipeline will destroy tens of thousands of high-paying jobs with benefits. Denying new gas and oil leases will increase energy prices and diminish America’s newfound energy independence from foreign suppliers.

I’m not going to get too deep in the weeds here, but because the Senate added amendments to the bill, it had to go back to the House, which needed to sign off on the changes. This afternoon it did. The House passed the resolution. A final bill will be drafted and passed through an obscure process called reconciliation, which would deprive the Republicans of the ability to filibuster the bill (although under Senate rules this can only be used once per fiscal year and for that reason is usually reserved for major legislation such as tax law changes).

Difficult To Comprehend: The size and scope of this spending program are difficult to comprehend. Nothing like it has ever occurred in U.S. history, except for FDR’s effort to redirect the entire U.S. economy as part of the effort to win World War II. It will provide aid to some in need but, it will also supply windfalls to favored political interests, whether they are in need or not.

This $1.9 trillion comes on top of the $900 billion spending package passed last month and the $3 trillion of spending packages passed by Congress between April and June in 2020. Of course, this entire run of (essentially) $6 trillion in COVID and economic relief is in addition to the $1 trillion baseline budget deficits already built-in for fiscal 2020 and fiscal 2021. The total deficit spending tab for both years, pandemic and non-pandemic, comes to $8 trillion.

More economic stimulus is waiting in the wings. After the new $1.9 trillion package passes, the White House and Congress will likely pursue another multi-trillion dollar deficit spending program focused on infrastructure, education and aid to state and local governments. Republicans may complain about such big-ticket spending, but their complaints will carry little weight. When Republicans were in control of the White House and Senate in 2020, they passed over $3 trillion in deficit spending programs to deal with the pandemic.

Right now, there is no fiscal discipline. COVID has become an all-purpose excuse for practically unlimited spending. What it will not do is stimulate the economy or end the no-growth and slow-growth depression we are now in. Obviously, the policy response to the pandemic caused the new depression.

The Worst Decline Since 1946: The final numbers on the economy for 2020 are in (subject to the usual adjustment processes). GDP growth in the U.S. for 2020 was negative 3.5%. How bad is that? It is worse than in 2009 when growth collapsed by about 2.4%. It is worse than the 2000 and 1990 recessions, which were both quite mild. It is worse than the severe recession of 1982 when growth fell about 2%. In fact, it is the worst decline since 1946 in the midst of the demobilization after World War II.

Before that, you have to go back to the Great Depression years of 1930, 1931 and 1932 to find a worse collapse. In a $22 trillion economy, a 3.5% collapse equates to about $770 billion in lost output. The actual damage was far greater because output figures and GDP do not capture lost wealth in the form of failed businesses, lost skills, and declining asset values in commercial real estate, airlines, resorts, cruise ships and many other endeavors.

The 2020 collapse was bad enough, but where do we go from here? How will the Biden policy plans play out in the real economy regarding growth, jobs, inflation or deflation? Most analysts and TV commentators say that growth will come roaring back in 2021, and we’ll be back to 2019 levels of output by mid-year. Don’t believe it.

The Biden plan will hurt growth, destroy jobs and produce a new recession as early as the first half of 2021. The overall effect will be deflationary (although inflation will follow in 2022 and later as the effects of deflation become unsustainable due to debt burdens and reduced consumption). The pillars of Biden's program boil down to two things. One is his monetary policy, which consists of zero rates and money printing. The second is his fiscal policy, which includes deficit spending and a higher debt-to-GDP ratio. This will be exacerbated by higher taxes, lower wages (due to more immigration) and more regulation. It’s a recipe for economic disaster.

No Velocity: Monetary policy will fail because velocity is falling faster than money can be printed. Velocity measures turnover, the rate at which money changes hands. Velocity peaked in 2008, just ahead of the global financial crisis, and it has continued to plunge until it took a total cliff dive in 2020 during the pandemic. This is why the Fed has been printing so much money. It takes more money just to keep GDP constant when velocity is collapsing. When velocity drops, you get less “bang for the buck” in terms of economic growth.

The Fed has very little control over velocity. That’s because velocity is driven by psychology and inflationary expectations. Right now, expectations of inflation are low. People don’t want to spend; they want to save or pay down debt. The result is that velocity continues to drop, which is a major headwind to growth.

The Fed’s solution (now endorsed by Janet Yellen, former Fed Chair and new Secretary of the Treasury) is more deficit spending by the Congress. The idea is that if citizens won’t spend, Congress will. The goal is to accelerate money velocity. That might work when you have little debt. But that’s obviously not the case today.

Like Greece, Lebanon, Italy and Japan: The debt-to-GDP ratio is the total amount of U.S. government debt divided by GDP. The U.S. debt-to-GDP ratio is about 125% today. That ratio will get worse once the new Biden spending bills pass, pushing the debt-to-GDP ratio to 130%. The only other developed countries with debt ratios that high are Greece, Lebanon, Italy and Japan.

This debt-to-GDP ratio is highly significant. The research shows that at debt-to-GDP ratios of 90% or less, there is a Keynesian multiplier from government borrowing and spending. You can borrow a dollar, spend a dollar and get, say, $1.25 of GDP. The multiplier drops as the ratio gets higher, but as long as you do not surpass a 90% ratio, there is still some bang for the buck. Once you hit 90%, the multiplier is less than one. The U.S. crossed this critical threshold in 2011.

This means if you borrow a dollar and spend a dollar, you get less than $1.00 of GDP. You’re now in a debt death spiral. When the debt is that high, you can’t borrow your way out of it. Each dollar of additional borrowing adds a dollar to the debt but adds less than a dollar to GDP.

An economic time bomb is ticking. Velocity is dropping. Debt is growing. Growth is slowing. The explosion will come in the form of asset bubbles bursting, stocks crashing and soaring gold prices. It’s a debt death trap."

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