Is deleveraging just a delusion?December 14, 2010: 6:17 AM ET
Well, that was quick. The new frugality lasted all of two years. Is that good or bad?
One takeaway from the newly minted Federal Reserve quarterly flow of funds report is that America has stopped paying down debt.
Private sector debt fell by $165 billion in the third quarter. That is just a quarter of the rate of decline a year ago, Capital Economics notes. But what's more, government debt issuance more than canceled out that drop, expanding by $380 billion during the period ended in September.
That gap, if you can bear it, stands to get even bigger in coming quarters should Congress approve the deficit-expanding tax deal reached this month by the White House and congressional Republicans.
That shift is not exactly reassuring the many fiscal hawks who warn that U.S. profligacy will not end well. They say the wider the budget gap, the bigger the mountain of debt sitting atop U.S. assets. Both of those trends, they claim, will push the dollar toward collapse in an inflationary crisis reminiscent of a banana republic.
If the ever-growing U.S. budget deficit is exhibit one in this lecture, exhibit two is the staggering level of debt piled up on all levels of society, as measured by the ratio of nonfinancial debt to economic output. Though there has been some talk of Americans getting their financial houses in order, there is not a lot of evidence of it to look at this number (see chart, right).
While financial firms have indeed cut their debt by 16% or so since the financial crisis broke out two years ago, nonfinancial debt – that carried by consumers, government and nonfinancial businesses -- remains just 2 percentage points below its bubble-era peak, at 243% of GDP.
"So you can forget about all that deleveraging talk," says Euro Pacific Capital economist Michael Pento, who believes the dollar will collapse in an inflationary whirlwind. "The U.S. is in fact still leveraging up, both in nominal terms and as a percentage of GDP."
Yet as irresponsible as this might sound, there is an argument in favor of this unexpected pause in our deserved march to austerity -- which is that it just maybe could keep the economy staggering forward for a while as the search for a new growth engine goes on.
The observation that American consumers have stopped adding to savings and have returned to spending is admittedly unnerving, because it was our profligacy that put us in this fix in the first place. Everyone will be rightly concerned if the saving rate dives back toward zero and debt levels start climbing again.
But for now, a bit more spending and a bit less scrimping could pave the way to better growth and, Ben Bernanke no doubt hopes, more of the same down the road. And as he knows, it is only through higher growth that we will be able to overcome climb our unhappy debt mountain.
The unexpected rise in consumer spending is part of the reason economists at the likes of Goldman Sachs and UBS have been raising their U.S. growth forecasts lately.
"This is a pretty important shift," Goldman economist Jan Hatzius said this month. "This is why are we turning more upbeat on U.S. growth after being downbeat for the past five years."
There is another aspect to this story, which is that as spendthrift and irresponsible as Americans have been, their banks and other so-called financial intermediaries were even worse – which means their debt levels perhaps have further to fall.
Financial sector debt amounted to just 24% of nonfinancial debt in 1990, for instance. Even after all the banking sector deleveraging, that number was 40% in the third quarter of 2010. Everyone in the United States has some belt tightening to do, but surely some more than others.