The Hidden Hand of Debt
by Llewellyn H. Rockwell, Jr.
In the second half of 2001, American politicians urged consumers and
businesses to go on a spending spree as an act of patriotism. This is bad
economics, and a lousy form of patriotism as well. A recovery purchased at
the expense of financial security can lead to disaster.
The usual pattern in a recession is that individuals and businesses pull
back on spending and borrowing. Superfluous investment projects are
abandoned, loans are called in, and belts are tightened all around. This
leads to accumulated savings and lower interest rates, which work together
as a solid foundation for economic growth.
That has not happened this time around. Instead of dumping debt, debt of all
kinds has reached very dangerous highs. With new mortgages, car notes, and
high credit card balances, Americans have driven up total consumer credit to
a record high of $7.5 trillion (an increase of 8.5 percent in a year).
Meanwhile, credit-card delinquencies are rising as consumer assets are
falling.
The corporate sector is faring no better. US nonfinancial, nonfarm companies
accumulated a record $4.9 trillion of debt as of the end of the third
quarter. Again, this is occurring during the part of the business cycle when
companies are supposed to be unloading debt and curbing their financial
ambitions. Corporate debt is up 6.6 percent from one year ago.
Total corporate debt is now at half the total US gross domestic product, up
from one-third in 1994. No wonder that in corporate bond ratings, there were
three times as many downgrades as upgrades in 2001.
All this spending and debt accumulation may be creating the illusion of
prosperity without the underlying reality. There is nothing inherently wrong
with debt, but massive accumulations during a recession is anti-recovery.
For promoting this spending spree, and making it manageable, the Federal
Reserve is responsible. In 2001, the Fed has driven interest rates from 6
percent down to 1.75 percent, with a resulting explosion in the quantity of
dollars sloshing around the economy. In real terms, the discount rate is at
or below zero.
There are consequences to such actions. The three most common measures of
money - M2, M3, and MZM - reveal year-on-year increases running between 10
and 20 percent. MZM increases even reached 40 percent after September, so
that a total stock of money in late 2000 of $4.5 trillion has soared to $5.3
trillion by the same point in 2001.
What's the problem? In Chicago School economic models, this massive
injection of money beyond the ability of the economy to absorb it causes
prices to increase and purchasing power to fall. This is evidently not
happening right now, but there are other effects that only the Austrian
School of economics explains.
The new credit makes possible spending and investment that would otherwise
be unsustainable. In other words, unwarranted debt creates financial
bubbles. Down the line, the Fed will face a choice between tightening
credit, prompting a downturn once again, or continuing the injections of
paper and risking making imbalances even worse.
There are immediate dangers as well. Servicing debt at the low rates we have
today can be manageable. But what if rates begin to rise? Businesses and
households will face financial burdens that they cannot bear. Political
pressures will increase for the federal government to come to the rescue
with bailouts and subsidies, all of which are paid for in some way
(inflation, taxation, or more debt).
Recessions are not a problem for otherwise free economies. The coordinating
magic of the price system helps all resources find a home in a manner
consistent with economic realities. However, recessions are a problem for
the political system, particularly those with election cycles, which is why
governments are forever trying to "stimulate" economies that are undertaking
the hard work of cleaning a house soiled by central-bank generated
malinvestments.
Sadly, there are no shortcuts to real prosperity. Neither cheerleading nor
artificial injections of liquidity are a viable substitute for old-fashioned
rebuilding. Real economic growth can't be created by a printing press.
At a time when the political establishment is using happy talk to generate
the appearance of happy days, and spending untold billions on war, no one
wants to hear the message that there is a price to pay for this profligacy.
But that doesn't change the reality.
Let's say your best friend came to you and admitted that he is in over his
head in debt. Every penny of his income, he says, goes to paying off twelve
credit cards. What would your advice be? If you said, no problem, just apply
for more credit, would you be behaving like a real friend?
It's even worse with government, which first tells Americans to live it up
during a time when we can least afford it, and then manipulates the credit
system in a way that makes it seem that there is no price to pay.
January 9, 2002
Llewellyn H. Rockwell, Jr. [send him mail], is president of the Ludwig von
Mises Institute in Auburn, Alabama, and editor of LewRockwell.com.
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