Last updated on August 21st, 2011
If used within reason, leverage will sustain growth. But if used in excess, leverage will destroy. Much of the developed world has been using excess leverage for far too long, and many believe we are in the end game of the current economic cycle.
I believe that most of us instinctively know the real reason behind the great recession that we have been in, that is, too many people are in too much debt. For too long, easy money and easy credit through extremely low interest rates and willing banks, has fueled the engine of economic growth. The problem is, there is always and end to this particular game, and it’s not a pretty ending.
Debt upon debt is not sustainable and eventually must be de-leveraged or unwound. Why, you ask? Well, despite the fact that banks had been allowing insane levels of borrowing with virtually no down-payment, or none at all (thanks to willing Fed and gov’t policies), or proof of the ability to pay the loan, there is only so much money that you can possibly borrow and actually afford to make the payments. Although this is so common-sense, how could so many have allowed themselves to go to the razor edge of income versus ability to pay? Once maxed out, there is no other option but to pay the loans while having no money whatsoever to continue to borrow more. Game over.
The debts must be paid off or the assets sold. There is no other way.
During late 2007, when the tipping point occurred, the slow healing process began. People began to pull back on their spending, mostly from necessity (they couldn’t borrow any more – they were maxed out). This in turn slowed down the ‘economy’ which in turn set in motion company layoffs and cutting corners to maintain profits. This in turn led to lower tax revenues collected by local, state, and federal governments. A viscous circle which requires that all participants cut back, de-leverage, and reduce debt.
The US federal government (and many others), instead of cutting back on it’s own expenditures, as the rest of us must do, is instead spending even more, resulting in an enormous debt burden that cannot possibly be paid off at current levels. If we stop paying our mortgage, the bank will take our home. The government however has something that we don’t have, a printing press. They are trying to avoid a very painful system crash by spending even more money (printing both digital money and paper money) while at the same time encouraging citizens to spend more.
During 1929 leading into the Great Depression of the 1930’s, US household debt as a percentage of GDP was 100 percent.
Leading into today’s Great Recession, household debt again had reached 100 percent of GDP.
The de-leveraging period during the Great Depression of the 1930’s resulted in an 80 percent reduction in household debt of GDP, while today US household debt has only decreased by about 8 percent. There has been no where near enough de-leveraging.
So, one might logically conclude that the Greater Great Depression has only just begun…
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