By David Stockman as originally published on Contra Corner and reprinted here with permission
This is getting pretty ridiculous. For old times sake, we recently checked on the Federal debt level during the month we arrived in the Imperial City as a 24-year old eager beaver. That was June 1970 and the Federal debt held by the public was $275 billion.
Mind you, while that number wasn’t exactly diminutive, it had taken all of 188 years to accumulate. That is to say, Uncle Sam had borrowed an average of $28,000 per week during the 9,776 weekssince George Washington was sworn in as the nation’s first president.
We are ruminating about this seeming historical obscuranta because it just so happens that the US treasury this very week will be selling $258 billion of government debt.
That’s right. Uncle Sam’s scheduled debt emission this week will nearly equal his cumulative borrowing during the nation’s first 188 years and its first 37 presidents!
And, yes, there has been some considerable inflation since June 1970. And not the least because exactly 13 months later Tricky Dick Nixon decided to pull the plug on Bretton Woods and the dollar’s anchor to a fixed weight of gold.
Needless to say, the financial discipline of gold-backed money during that interval of guns and butter excess would most certainly have triggered a recession and a heap of inconvenience for Nixon’s 1972 reelection prospects. As it happened, the American economy got a heap of inflation and destructive financialization over the next half century, instead.
Accordingly, the price level today is 5X higher as measured by the GDP deflator. So in today’s dollars of purchasing power, the 1970 debt figure would be about $1.2 trillion.
This is by way of explaining that it hasn’t been for nothing that we have labeled the Donald as the King of Debt and the Congressional Republicans as fiscal Benedict Arnolds. Their now enacted budget plan—-which they have the gall to crow about from one end of the country to the other—-is to borrow as much money in apples-to-apples dollars during the year ahead (FY 2019) as did the first 37 presidents of the United States!
Accordingly, Keynesians, beltway politicians of both parties and Wall Street punters, alike, know this: The US has a monumental debt problem, and it is most definitely not “priced-in”.
So our purpose in this two-part series is to explain how it came to be not priced-in, and why that anomalous state of affairs is coming hard upon its sell-by date.
To be clear, we are not talking about just the $21 trillion of public debt that will be on the books after this week’s borrowing binge, but the entire $67 trillion albatross of public and private debt that now strangles the US economy.
We refer to the latter as the lamentable outcome of the rolling national LBO that the US economy has undergone since June 1970.
The fact is, the $1.5 trillion of total public and private debt outstanding back then amounted to150% of GDP. And that implicit 1.5X national leverage ratio had essentially remained unchanged for the prior 100 years of robust economic growth and 25-fold rise in real income per capita.
By contrast, at $67 trillion of total debt today, the US leverage ratio stands at nearly 3.5X, and therein lies the giant financial skunk in the woodpile. Had the historically proven leverage ratio of 1.5X national income not been upended by Tricky Dick’s perfidy, there would be $30 trillion of total debt on the US economy today, not $67 trillion.
So those two-extra turns of leverage amount to $37 trillion—–an economic millstone that is grinding capitalist growth steadily lower, and which has now put the main street and Wall Street economy alike in harm’s way.
That’s because the massive growth of central bank credit unleashed by the Camp David folly of 1971 has finally reached its limit—even by the lights of our overtly Keynesian central bankers. So they are now embarking upon an epochal balance sheet reversal that will drastically alter the fundamental dynamics of the financial system, and expose the vast falsification of financial asset values that are actually “priced-in” to today’s Wall Street house of cards.
Indeed, it was today’s Keynesian mind-frame that caused Nixon to jettison gold in the first place: He was advised by what we have called the “freshwater Keynesians” around Milton Friedman, who were every bit as statist on the matter of money and macro-economic management from Washington as were their “saltwater” compatriots in Cambridge, MA. They merely differed on technique as between monetary versus fiscal policy tools.
Alas, when practiced over a long enough time frame, however, Keynesians—and the politicians and apparatchiks who find it convenient to embrace their fataly flawed model—literally loose their minds. That is, insofar as historical memory is concerned.
Stated differently, they become incurably infected with “recency bias”, and so doing end-up absolutely blind to the unsustainable errors and anomalies on which they whole debt-fueled scheme is predicted.
For instance, had your editor also checked in at the Eccles Building during his taxi ride from national airport to his new digs on Capitol Hill in June 1970, he would also have found that the Fed’s balance sheet stood at a mere $55 billion. And that was after 56 years in the money printing business.
What happened during the next 48 years, of course, was nothing less than a monetary eruption—-the very thing that Nixon’s Camp David folly enabled. To wit, the Fed’s balance sheet exploded by 82X or by nearly 10% per annum over the course of a half century.
It goes without saying that you could not have found one economist (or even layman) in Washington, Cambridge or Chicago in June 1970 who would have recommended or even imagined an 82Xexplosion of the central banks balance sheet during the next 50 years. Even the reining monetary populist and crackpot of the day, Congressman Wright Patman of Texas and Chairman of the House banking and currency committee, would have never countenanced such a thing.
The rest is history, of course, and it couldn’t have been imagined, either.That is, the 82X explosion of central bank credit gave rise to the freakish chart below.
To wit, in June 1970 the GDP was $1.1 trillion and it has since expanded by 18X to $19.6 trillion. By contrast, total public and private debt outstanding was $1.58 trillion and has since expanded by 42X to $67 trillion.
Needless to say, to grow these unsustainably divergent trends for even another decade would lead to an outright absurdity. To wit, $35 trillion of nominal GDP and $150 trillion of total debt.
In fact, the ridiculousness of it perhaps explains why the Fed stopped publishing the total credit market debt figure in its quarterly “Flow of Funds” report in Q4 2015 when the number stood at $63.5 trillion. But the components are still there and they do add to $67 trillion.
Needless to say, this chart makes all the difference in the world for the impending era of interest rate normalization and quantitative tightening (QT). It is one thing to permit interest rates to rise by 200-300 basis points in a context when the economy is carrying $30 trillion of debt; it’s an altogether different kettle of fish, of course, when the burden is $67 trillion.
In short, recency bias is going to prove to be the Achilles heel of the now ending era of Bubble Finance. The US economy has been borrowing and printing money so long that its position on the economic and financial map has been lost sight of—meaning that the impact of the coming epochal reversal at the central bank is not even remotely appreciated.
Take the matter of the Fed’s balance sheet. Even had the US followed Milton Friedman’s fixed money growth rule at approximately 3% per annum, the Fed’s $55 billion balance sheet of June 1970 would stand at just $230 billion today.
Do we think that $4.2 trillion of extra central bank credit has changed everything?
Yes, we do—as we will amplify in Part 2.
In the interim, however, here is the singular stat that should scare the bejesus out of casino gamblers who remain drunk on the trading charts embedded in robo-machines and the fancy bespoke trades peddled by Wall Street brokers.
Up to $2 trillion of central bank balance sheet shrinkage has never happened before. Nor has the impact been any more imagined at present than had been the 82X explosion of the Fed’s balance sheet back in June 1970.