The problem is private debt

Since I am still sick, I am going to do a series of short posts until I feel well enough for longer-form stuff.

Here I just want to mention the Paul Ryan budget, which looks to balance the US budget via budget cuts. Now I get the ideological bias against big government and the corollary that government spending should be held in check for this reason. That’s a philosophical or ideological view. I get that. But what is always disconcerting for me is how it’s not the ideological point that leads. Rather it is the false economic narrative.

Why does the federal government need to balance its books? Where does the money come from that the government spends? Whose income gets cut when spending gets cut? These are a few of the questions we should be asking when thinking about cutting or raising taxes. My view is that government deficits should be economically endogenous, meaning that they are the outcome that results from private sector savings and investment decisions and public sector policy choices. The deficit is not a goal. Making it a goal of policy makes policy an exogenous variable and brings uncertainty and pro-cyclicality into the business cycle.

Moreover, private debt is the real problem in Europe and North America. What has happened over the last generation is that households and businesses loaded up on debt as interest rates declined. Policy makers did not allow this increase in debt to fully unwind during cyclical downturns, and this created a secular increase in debt levels throughout most private sector economies in Europe and North America. The result now, with interest rates at their lowest levels, is that there is no room for maneuver. Either private debt level have to rise more for the credit accelerator to boost economic growth or the government takes up the slack or we simply don’t grow. 

Just as targeting deficits amplifies business cycle volatility, setting policy to counteract deleveraging also has distortionary effects by socialising losses and loading up what was private debt onto the public sector. Call it an non-target specific catch all bailout because the effect is the same as targeted bailouts in that private debtors are relieved of their debt burden by government’s taking it over. Now some of this is inevitable as the private sector net saves and induces a public deficit. However, a lot of it is unnecessary because the answer lies in reducing private debt via writedowns, defaults, debt forgiveness or debt jubilee. Debts that cannot be repaid won’t be and there is no sense in trying to repay them. It’s better to clear the decks and move forward.

That’s my general comment here. The reason I make it is because that’s not how these things are likely to get solved. We are likely to continue to see loss socialization, bailouts and deficit fetishism for some time to come. And the result will be low growth and susceptibility to recession until the private debt levels have been reduced to less systemically challenging levels. This is the backdrop for a secular bear market, not a secular bull market. So I do expect multiples to expand now during the cyclical upturn as they have done. But I also expect the next downturn to have an unusually severe negative impact on multiples, bringing stock prices down by a considerable amount.