Overleveraged America has no Plan B

WASHINGTON – Is America once again at the edge of some catastrophic event that will cause economic misery? Not by a long shot, most would argue. The economy, although a bit slower in the second quarter of 2019, is till chugging along, with a respectable 2.1 GDP growth. Unemployment at 3.7% is still at its historic lows, while jobs creation (about 165,000 a month this year) is quite substantial. So, where is the problem? The problem is too much debt.

Too much debt

It is well known that credit is the fuel of capitalism. And this is why a modern, well functioning financial sector is so critical for growth. Savvy bankers and venture capitalist most of the time will allocate capital to deserving established or new enterprises. This properly targeted new credit (or investments) will foster the growth of healthy companies or new ventures, often creating more innovation, new jobs, and eventually broader prosperity.

Corporate debt

And yet, if we look at the $ 9 trillion of US corporate debt, much of this massive burden is not about new investments. Some of it at least is about cheap capital used to buy back stocks, in order to prop their value. Which is to say that at least some of the impressive stock market buoyancy is an optic illusion. It is made possible by historically low interest rates that allow corporation to obtain cheap credit used not for investment in technology and expansion, but for financial manipulation.

Consumers are overleveraged

And what about US consumers? Their financial health and optimism about their economic and financial circumstances are absolutely critical, since private consumption in America, at 70% of GDP, is by far the most significant factor affecting economic growth.  

Well, here
is another mixed bag. As noted above, the economy is growing, new jobs keep
being added, and unemployment is extremely low. Still, things are not great for
the American middle class. Millions of relatively young people carry an
extraordinarily high student debt load. Combined with car loans, other consumer
debt and child care expenses for those who have children we have a picture of
individuals or families that can barely survive, even on relatively good income
(above $ 100,000 or more for a couple).

Millions of new young professionals simply cannot afford to buy a house because the existing debt they have to pay off prevents them from saving enough for a down payment, let alone adding monthly mortgage payments to the long list of existing obligations.

More federal debt

The Federal Government is playing a negative role in all this. Democrats and Republicans who these days agree on almost nothing, very quietly just passed a new spending bill that increases defense and other discretionary spending, without even a word on the need to seriously consider reforming the major entitlement programs (Social Security, Medicare and Medicaid are the big ones) that slowly but surely increase –every year—federal spending. The net result of this political accord is more federal spending, higher deficits and more debt, at a faster clip than forecasted even a year ago.

Debt, debt everywhere

So, here is
the picture. Corporations are high into debt. The American consumers,
especially the younger workers, even those with above average income, carry an
enormous debt burden that is made tolerable only by extremely low interest
rates. The Federal Government, both parties having forgotten any concerns about
fiscal responsibility, is piling up new debt at a fast clip –while a growing economy
is at full employment.

To top it
all off, the US Federal Reserve just cut interest rates, this way signaling that
the happy era of ultra-cheap credit will continue, who knows for how long.

All is well?

At the
moment, none of this concerns anybody. If asked, policy-makers will tell you
that things have rarely been so good for the US economy. On the surface this is
true. But we have to pray that nothing will happen.

If for some
reason we have a re-ignition of inflation that may force the Federal Reserve to
raise interest rates and therefore increase the cost of borrowing throughout
the economy, this whole thing may collapse.

Cascading effects

When
consumers can no longer pay existing debts and buy new things at the same time,
there will be a contraction in spending that will immediately reverberate
throughout the economy. Lower demand means lowers sales, and therefore job cuts.

Think of
the millions who can barely make it today, while having a good or at least
decent job. Imagine their predicament if they lose that job! They will default
on all their loans. Their cars will be repossessed. As a consequence, much of
their consumer loans and credit card debt will have to be written off, with
considerable losses for the banks that extended it. And this means a major
recession.

Doomsday scenario

Look, may be none of this will ever happen, and this doomsday scenario will remain fiction. Still, I am truly concerned when America –the largest economy on earth– has essentially no margin, no cushion. All the key players: corporations, consumers, the Federal Government and the Federal Reserve are overextended.

Usually
when a recession hits, the Federal Government increases spending in an attempt
to inject liquidity and stabilize the jobs market.

But today
Washington is about to go back to $ 1 trillion deficits, justifiable only when
America was trying to emerge from the devastating financial crisis of 2008. It
will be hard to increase federal spending when deficits are already so high.

Again, let’s
pray that nothing bad will happen. But prayer is hardly the most sophisticated
contingency plan for a $ 20 trillion plus overleveraged economy.