Monday, March 21, 2011

Shifting Burdens of Debt Still Weigh on Economy

If you had the chance to watch the video interview with Ray Dalio of Bridgewater - posted last week on Random Glenings - you saw a terrific explanation of the process of leveraging/deleveraging that economies through history have experienced.

As Dalio discussed, much of the economic growth in the United States over the last decade or so was fueled primarily through debt.

This is the pattern that many countries throughout history have followed, most notably Britain in the 19th century and Japan in the latter part of the 20th century.

The problem with taking on debt to boost economic activity is that eventually the bill needs to be paid. When this time comes, countries face years of sluggish economic activity, as growth in real income is needed to repay lenders. For example, even before the calamities of the last few weeks, Japan's economy was mired in the malaise that had plagued it for more than 20 years.

Dalio believes that the U.S. is in the midst of this deleveraging process, and I agree. This means, among other things, anemic economic growth, low wage growth, and potentially deflationary pressures.

For the stock investor, this period is not necessarily bad. Low interest rates will tend to boost values of common equities, assuming that the underlying economic growth is at least modestly positive.

Floyd Norris had a good column in Saturday's New York Times discussing how both the financial and household sectors have been reducing their debts at a rapid pace:

Over the last two years, financial sector debt fell by nearly 9 percent each year, for a total reduction of $2.9 trillion. To put that figure in perspective, it is more than the entire financial sector debt that was outstanding in 1990, the beginning point for the accompanying charts.

It is also larger than the $2.5 trillion total current obligations of state and local governments.

While on the surface this data is encouraging - since it means that we are moving along briskly in the deleveraging process, which sets the stage for future economic growth - the chart accompanying the article illustrated just how large the debt burdens of our society have become.

For example, while Norris correctly heralds the fact that total debt in the financial sector has fallen significantly, it still stood at an eye-popping $14.2 trillion at the end of 2010. Household debt - which helped fuel the economic growth over the last decade - stood at $13.4 trillion at the end of 2010.

And here's one more sobering fact. While it is true that both financial and household debts have been declining over the past couple of years, debt at the federal government level has grown by nearly the same amount - $3 trillion.

In my opinion, then, all this means that the debt burden for our society has been shifting more to the government, and away from the private sector, meaning potentially more deleveraging pain ahead.