Hoisington First-Quarter Review and Outlook

This week John Mauldin's Outside the Box features Hoisington First-Quarter Review and Outlook.  As is typically the focus there is much detail surrounding the current US debt situation and the crisis that surrounds it in a lack of leadership in order to make some tough decisions.


Highlights from the piece (See full PDF version below)

• The standard of living of the average American continues to fall. Real median household income today is near the same level as it was fifteen years ago, a remarkable statistic since the debt to GDP ratio is 100 points higher (Chart 1). The cause of this deterioration in living standards can be traced to the excessive accumulation of debt, as well as the debt proportion that has turned increasingly unproductive, or even counterproductive. When debt is utilized to finance nonproductive assets, an economic process is initiated that undermines prosperity. Productivity gains must be generated in order to boost income, and thereby the standard of living. If debt enhances productivity, incomes will expand and the economic pie will be enlarged. Otherwise, the debt increase exercise is debilitating to economic growth.
• The negative feedback loop arising from the unproductive nature of this debt accumulation is straightforward.  First, United States government spending carries a zero expenditure multiplier, as do operating expenditures of state and local governments.  Thus, each dollar spent by the federal government creates no sustainable income, yet the interest payment incurred with each borrowed dollar creates a subtraction from future revenue streams of the private sector.  Second, much of the massive debt increase over the past decade has been in the form of mortgage debt.  Jobs and income were created with the expansion of the housing stock.  However, no productivity gains are evident in this housing stock increase, which means future incomes have not expanded.  Nevertheless, the repayment of principal and interest weighs down the system, and the consequences of delinquency, foreclosure, default and bankruptcy compound the problem.
• Third, debt that is utilized to finance consumers’ daily needs obviously fails to generate any productivity or future income growth.  Efforts by fiscal and monetary authorities to sustain growth by further debt accumulation may produce some short-term benefit.  Sadly, these interludes fade quickly as the debt becomes more destabilizing.  The net result of increased indebtedness then becomes the opposite of what policymakers intend when they promote economic growth by either borrowing funds for increased government expenditures or encourage consumers to borrow with artificial and temporary incentives.
• There is a longer-term negative feedback loop that has been referred to as the “bang point” by economists Reinhart and Rogoff, and it occurs when government or private borrowers are denied access to further credit because the marketplace has no confidence that new or existing debt can be repaid.  At this point interest rates soar and debt issuance becomes impractical; therefore, the government or private borrower is forced to live on current revenues.  As recent cases in Europe have documented, this is painfully disruptive, with high social costs.  We do not believe this point is at hand for the United States, but it has occurred many times historically, including in contemporary Europe.  If it were to happen in the U.S. now, the consequences would be traumatic since 42 cents of every dollar spent by the federal government in the first six months of the current fiscal year was borrowed.  The chaos that would be created by a reduction in federal government spending of 42% is unimaginable.
• Contrary to common wisdom,  monetary and fiscal policy actions that spur growth by increasing debt may buy transitory gains in some measures of economic activity, but they perpetuate this disequilibrium. Increasing debt merely makes the economy more vulnerable to economic weakness and potential instability because income growth is stunted or, as previously stated, over-indebtedness cannot be cured by more debt.  Periods of over-indebtedness change the sacrosanct rules of thumb of business cycles.  The conventional wisdom of business cycle analysis that suggests five to seven good years followed by one to two bad years is broken.  Normal risk taking is not rewarded.