The Great American Debt Sentence

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Don't miss today’s Debt Rattle, May 2 2008: Grand Theft Auto on Wall Street

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Ilargi: Every now and then it's good to remind people how deep inside the quicksand our economies have really sucked themselves. Sometimes I get the feeling those reminders will be particularly appreciated by the same crowd that loves horror stories. This one's from Karl Denninger.


Investable Capital - And Why It Matters

Back in 2005 on Musings I talked about "The Coming Fiscal Meltdown of America", with a focus on the public debt which, at the time, was about $45 trillion, including Social Security and Medicare.

Of course we have now added to that materially, with the entitlement spending going insane, and now have a number that is closer to $62 trillion, all-in.

Yes, it is rising that fast, even though we only "count" $9 trillion or thereabouts.

Now let's talk about why it all matters.

The government debt (public debt) is only a small part of the problem. The far bigger one is private debt.

These are best expressed in terms of GDP, because that's what really matters. After all, if you have $1 trillion in debt that sounds awful, but if your GDP is $20 trillion, it is in fact trivial (5% of output) and easily serviced.

Unfortunately we have reached truly unprecedented levels in the United States.

Private debt is currently running at 170% of GDP excluding financial components, and 280% if you include them.




Past crisis incidents and recessions have featured much lower numbers. For example in 1929 it was about 150% (non-financial), and didn't reach over 200% until 1932, as the Depression induced tremendous asset deflation and output falls.

In 1980 it first started reaching for the 100% mark; in 2004 it was 144%.

To figure out how bad this could get you need to know the debt service costs; if we assume a conservative 8% interest rate on all such debt (remember, credit cards and car loans are included, not just mortgages!) we get a GDP "coverage ratio" of 22.4% of GDP.

That's right - you need 22.4% of GDP just to pay the interest on the debt.

This, by the way, is why Bernanke fears deflation so much. See, if we were to see interest expenses rise and GDP fall by, say, 10%, we would force coverage much higher, and set off a cascade of defaults.

Unfortunately we are likely beyond the point where this outcome can be avoided.

Many people complain about our national debt, which currently stands north of $9 trillion. That's a lot, and it ignores Social Security and Medicare (which isn't really fair unless you're prepared to tell Granny she can't have either!)

But that's about 80% of GDP, in rough terms. Bad.

What's worse is our household and financial sector debts. Household debt now stands at 120% of GDP, and includes both mortgage and other debt (e.g. cars, credit cards, etc.)


Then you add in financial sector debt its 280% of GDP, as mentioned above, and that's probably understated - after all, do you believe all the so-called "Level 3" valuations?

Of critical note is that the household debt number was about 85% of GDP in 2002.

Essentially ALL of the last four years of "growth" were in fact purchased with debt - the money now having been spent but the debt service remaining!

Worse, the financial sector has increased leverage - debt - at a rate twenty five times that of GDP since 1957, in what looks suspiciously like a parabolic blowoff.

And household debt is even worse - from 1975 onward it too has gone on what is darn close to a parabolic tear, and has almost doubled since 2000. But GDP is up only about 30% in the same eight years.

Now let's add in demographics.

As you probably know the Baby Boomers are starting to retire. Well, they think they will anyway. As they do, the 401k and IRA money they have in the markets will be removed and spent. This is money that will leave the market "forever" as it will be turned into food, shelter, cruises - in short it will be consumed.

The bad news is that the housing mess has "pulled forward" what I wrote about back in 2005 to a degree that I did not forsee. My original projection was that we had until about 2015 or thereabouts to get our act together, perhaps a bit longer.

I was wrong.

Those who think this will be some kind of "V" or even "U" shaped recovery are delusional.

We will not return to "trend" growth of 3-4% annually. We can't. Oh sure, we can play "goose the number" like the stimulus checks will for a month or so, but the facts remain what they are, and the underlying realities will not change. They will, in fact, get worse - much worse - as the months and years wear on.

Do not be suckered into believing that there is some rainbow at the end of this mess - not for a good long time to come. Absent some fundamental change (such as enactment of The Fair Tax) it is simply not going to happen.

Sales tax revenues for the first quarter are down. This is an ominous warning as it means that real consumer spending is in fact down, irrespective of what the government tries to report.

You can't get away from paying sales tax, and on a national basis sales tax revenues declined.

Note that taxes are paid with pre-inflation dollars, which means that adjusted for price inflation (that is, using the "deflator") its even worse than it appears.

Consumer spending is going off a cliff in real dollar terms - right here, right now, with the most precipitous declines being registered in March.

Short term the market is severely overbought, being driven in the last couple of months by delusional traders who have bought into the rotation out of commodities and the monstrous "stick save" tactics of The Fed, yet most of these people stayed when the "hot money bubble" that Bernanke has brought rotated BACK IN to those same places.


This is foolish beyond words, but that's how The Street works - it creates the maximum number of bagholders at the worst possible time.

In the 2000-2003 Tech Massacre there were multiple rallies just like this one, and they were not buying opportunities - they were opportunities to get short. Why? Because they inevitably turned and retrace all of what was gained, plus more. If you calibrated your bets so you wouldn't be forced out - that is, you used sound money management - you were ultimately richly rewarded.

So it will be this time.

If you've been dancing to the long trade do not overstay your welcome.

The music will stop and there will be no prior warning.

When it does if you're long - you're dead.

Look back at the summer of 2001 for what is almost certainly ahead. People think that 9/11 was a horrifyingly bad plunge. They're wrong. Most of the damage - a 20% decline from the local top - happened before the terrorist attacks.

20% from here is roughly 280 SPX points, or awfully close to 1070, which is major chart resistance, in the SPX.

The bulls are delusional in their belief that we can restart the debt-creation and spending binge and return to "trend growth", and thus earnings can be maintained and advanced.

It cannot be done.

The money does not exist to service the debt, and debt costs in the private sector are rising, not falling, especially among households. Real interest rates and terms, especially on revolving debt (credit cards) are going up at insane rates.

Single-payment misses now result in maximum interest rates going to 30% immediately, where they stay for a year or more, where a couple of years ago a single payment miss often didn't result in anything other than a $30 late charge. The issuers know you can't do a 0% balance transfer any more, and the low-fee transfers all disappear as soon as you have a late on your report, so that avenue of gaming the system has been slammed closed.

A new report out within the last few days suggest that 30% of all credit cards are under threat of default. With half of all cards paid in full every month, this is a particularly nasty trend, and one you do not want to see continue.

But it will.

The HELOC game is over. Lines are being cut back and will continue to be, as that debt is basically unmarketable today on the secondary market, trading for a nickel on the dollar - when it trades at all.

Contrary to Kudlow's claims 40% of all corporations have debt rated "junk", and in an economic slowdown these are the firms that will default. Default rates got silly low the last few years, which led to silly terms. That will come back and bite the buyers of that debt - hard - over the next few years, adding yet more contractionary pressure to GDP and the economy.

Nothing goes in a straight line folks, but the inevitability of what is coming down the road is a simple matter of mathematics. Our politicians do not want to listen, but the fact remains that they created this Ponzi Scheme at the request of the banks and other financial institutions and were warned that it would turn out like this.

They ignored those warnings, and now that day is here.

I have several times warned people to raise cash. I still mean it - raise cash, and do it now. Use this "rally" to prepare, because at the moment you are in the eye of a hurricane - and the other side of the eyewall is coming.

Soon.

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