Coming of the Lost Decades

In search of never ending growth, the present day politicians have adopted Keynesian economics as their life blood and have distorted it completely.  In order for the illusion of growth to continue, countries have added humongous amount of debt and they continue to do so. The following table illustrates the point.

The left hand column represents debt as a percentage of GDP. Japan stands at over 200% while Canada is the best of the G7 Countries at 34%.

 However the information that each country presents in not uniform. For e.g, USA does not include trillions of dollars of unfunded liabilities of its Social Security, pension, Medicaid etc. If all the unfunded liability is included, the Debt to GDP ratio of USA will push north of 90%. Talk of cleaver accounting!

Debt per se is not bad. Some would argue that debt is even necessary to efficient utilization of capital in the society whereby excess capital is used for productive purpose.  However, through centuries of data and observation, it has been found that when debt is above 90% of the GDP of a country, it becomes a drag on growth. In other word, high debt is in effect a negative factor for growth.

Then we have to consider the rate of interest that is being paid on debt. Japan is able to finance most of its debt internally. Japanese population is willing to finance its Government’s gambling habit at one percent rate of interest. But with the aging demographics, that is changing and the ability of the Japanese population to save and finance is diminishing to a point that in the next five to 10 years time, Japan will be forced to borrow money from the world and would have to pay a much higher rate of interest.

Spain, on the other hand has another problem. While its debt is only 63% of its GDP, most of its debt is tied to its banking sector which is virtually broke. The situation in Spain is similar to Ireland, where banks financed the housing bubble and when the bubble finally broke, they were left holding collateral which are worthless. These zombie banks are surviving because politicians have taken over the bad loans and garbage from the private sector and have put them in the hands of the public. So in effect the general population is now holding the smelly can and is being asked to sacrifice in the name of Austerity.

In USA, while the debt monetization by FED has kept the rate of interest at a very low level, there is only one way the rate of interest can go and that is up. It may not happen tomorrow or next month, but when the Bond Vigilantes wake up and find that US debt level is unsustainable, they will demand their pound of flesh.

All these debts are now deleveraging. Even with the best of efforts of the central banks of the world and bending all rules like “Mark to Fantasy”, even with adding billions of new debt to keep the Ponzi  scheme going, countries are unable to pull the cart any further. Growth is non existence and unemployment is high. In USA, officially the unemployment is 9.1% but unofficially over 15%. In Spain it is over 22% and most of the unemployment is among the young. These are causing social friction not seen or heard even a decade ago. Already constant unrest in Greece is pushing its national production to the negative territory. How long before we see the GDP is negative in USA. Already the last quarter GDP has been revised downward and next quarter GDP is being estimated at 1%. Too much leverage has been put into the system which cannot take leverage anymore and create growth to pay for the debt. Headwinds are strong.

According to Carmen Reinhart, a senior fellow at the Peterson Institute for International Economics and a leading expert on financial crises. "If historic norms hold, deleveraging isn't pretty, and it is not a smooth process. We're already four years into this. I don't think the next six years look great."

The bubble economy of USA was fueled by consumers, who used home as ATM. They in turn were deceived by Greenspan and Bernanke into believing the rainbow and unicorn story. The consumers and businesses took too much debt. Total private sector debt was over 280% in 2008. Since then consumers and business have been paying off and reducing their debt but all such reduction is being negated by the Government and public sector.

Today states and municipalities in USA are finding themselves looking at the debt default monster in the face. With reduced revenue, they are scrambling to stay alive. They are looting their rainy day fund, just like Federal Govt. who is drawing from the unfunded pension obligation of their employees to keep the debt issuance going.  With every level of government resorting to sleight of hand to keep the illusion going, this amounts to generational robbery where the next generation will have to pay a heavy price for today’s politicians folly.

The deleveraging process has started and coupled with the demographics shift, we are looking for a long period of depression, may be as soon as the 2^nd half of the year 2011.