“How Does This Ever End?” An Interview With Lacy Hunt
The US economy is struggling with too much debt at every level. A debt jubilee isn’t going to solve it; and shifting demographics will likely make it worse. So, is America headed for two decades of lost growth like Japan? Dr. Lacy Hunt, who was interviewed by Erik Townsend on the latter’s MacroVoices podcast, considers the endgame for the US economy… Well, we could get lucky, Hunt says.
“The US economy could experience a modern equivalent of the California gold rush. In the 1820’s and 1830’s, we took on a lot of debt to finance the early canals, steamship lines railroads – it was over-investment, over consumption. The panic year was 1838. Martin Van Buren was president, he didn’t know what was going on. By this, the country languished very badly for 11 years, and then gold was discovered it California, led to a huge surge in national income, people were very careful how they spent their income.
“We paid off the debt of the 1820’s, 1830’s, and the economy recovered. In 1873, we had another panic year brought on by too much debt that financed the railroads – remember we built the central line first and then the northern and southern routes, a lot of feeder road industries that supplied the railroads over-expanded and it was over-investment, over-consumption.The panic year hit. Grant was no more knowledgeable of what was going on than Van Buren had been in 1838. We had no central bank, the government continued to balance its budget. We had a prolonged period of austerity, but by the early 1890’s, the problem had been solved, and we began to go on our merry way.”
“Irrational behavior” on the part of US policy makers means our economy will grow to increasingly resemble Japan’s over the long term…
“I think that our results will mirror Japan over time, certainly not on a quarter to quarter or annual basis, but they’re public and private debt is just under 600% of GDP. Our total public and private debt is about 373%. They’ve tried to solve an indebtedness problem by taking on more debt. There are many many examples of what has happened to extremely over-indebted economies.”
Hunt notes that there has been important recent work by Allen Taylor, also by a number of people in Europe. There is also work that’s been done historically. For example, the leader of The Enlightenment, David Hume- his famous paper on public finance, written in 1752 reaches the conclusion that:
…when a state has mortgaged all of its future liabilities, the state, by necessity, lapses into tranquility, languor, and impotence.
And there was Irvin Fisher’s 1933 paper on the consequences of extreme over-indebtedness, including pointing out that
“one of the factors that will happen will be that the velocity of money will be very weak, and so there has been a tremendous amount of work. It’s just generally speaking been ignored.”
Hunt points to an excellent summary was published in 2010 by McKinsey Global Institute…
“They looked at 24 advanced economies that became extremely over-indebted. The indebtedness brought on a panic year, such as 1929, 1873, 2008, and they followed the process through to completion.
It’s a very long process, and what it shows is that an indebtedness problem cannot be solved by taking on additional debt.
McKinsey says specifically that multi-year sustained rise in the savings rate, what they term austerity, is needed to solve the problem, and of course, as we all know, in modern democracies, that option doesn’t seem to exist.
So, we try to continue to use what has failed, and while we get transitory improvement in economic activity, the longer-term trend is to weaker and weaker economic performance.”
Moving on, Townsend asks, is the secular bull market in bonds really over?
“My view is that the secular low in long treasury bonds is not at hand – doesn’t mean that rates cannot go up, they have gone up quite a number of times since 1990 when this bull run started, but they’re not going to be able to stay up. The economy is too fundamentally weak.”
“The main consideration for believing that the trough is not at hand, is that nominal GDP growth and also the inflation rate is not yet at its secular low. There have been many transitory swings that will continue to be transitory swings, but thecritical factors that determines the nominal GDP of both working lower experiencing considerably slower growth and money supply, and at the same time the velocity of money is in a major downtrend.”
“In 1997, $1 of new M2 growth increased GDP by $2.20, and the first quarter of this year, it was down to $1.42. This reflects the fact that we have too much of the wrong type of debt. There are many other influences in velocity, but that’s the critical factor.
I think it’s important to remember that the velocity of money is very volatile.
The old secular low was reached at 1.2 in 1946, and that was the year in which we saw the daily, weekly, and monthly lows in the 30 year bond yield. Now, if that is the key factor, not the only factor, but the key factor, which is driving the velocity of money downward, then velocity is going lower because in Europe, which has debt to GDP ratio 100 percentage points higher than the U.S., velocity is at one and in China and Japan, which are also more indebted than the United States, velocity is around 0.5 to 0.6.”
So, Dr. Hunt explains, the US debt load willl continue to climb and velocity will continue to slow – unless, of couse, “we get lucky.”