Restructure debt, or lose prosperity and liberty

Karl Denninger draws our attention to an interview with David Stockman on CNBC (see below). Key points:

• Combining middle-class earners with government employees (aside from teachers), we see that millions of jobs have previously been lost and there is now no net gain in half the 130 million American jobs market. Stockman terms this the "new normal".
• Numbers are increasing among part-time earners, but their annual pay averages $20,000 instead of the middle class' $50,000. As Stockman says, you can't support a family on that.

This is industrialization in reverse gear. America - and even more so the UK - now faces a great question: are we prepared to watch our industry eaten away? Last month, it was reported as a sort of victory that Britain made a deal with China to export pigs to them. Though agricultural production is important - God speed the plow - I don't see a bright future for the whole nation as pig farmers.

In a digitized world and globalized economy, our problems are evident and important to our competitors. Back in September China's "Beijing Review" crisply summarized America's woes and their causes:

Increasing financial pressures forced middle class Americans to rely on debt to continue their current lifestyles. Meanwhile, thriving financial innovations on Wall Street have encouraged their lifestyle of high debt and high consumption. The median debt-to-income ratio of the middle class families climbed to 1.19 in 2004 from 0.45 in 1983. So basically, credit-supported over-consumption of the middle class laid the groundwork for U.S. economic prosperity over the past three decades.

The over-consumption can be corrected by cutting back - something that is certainly a matter of concern to Beijing - but though the spending song is over, the debt melody lingers on. Private and public debts are absorbing the resources that should go into trade and industry. Lowering interest rates further is scarcely possible, and as Michael Panzer reports in "Ready for some crowding out?", the need (especially in Japan and the USA) to roll-over huge amounts of debt in the near future may see a bond market revolt and higher interest rates, instead. Commercial finance may well become both harder to obtain and significantly more expensive.

Meanwhile, the burden of debt now lies not in interest rates but in the capital repayments. As average incomes fall (owing to the shift from higher-paying to lower-paid jobs), the liabilities will grow heavier in proportion. Some of this ballast may have to be ejected from the balloon if we are not to crash to earth.

Normally, one would say that letting debtors off the hook is a moral hazard, but I think the scale of the emergency takes us beyond that consideration. In any case, default is already happening piecemeal in the residential mortgage market, and would be far more extensive if lenders constrained by capital adequacy requirements were not reluctant to foreclose. Beneath the tide of "jingle mail" is a savage undertow of tolerated delinquencies (*). Similarly, the banking sector would be pretty much dead if the government had not also been willing to defer foreclosure.

The challenge is to tackle the debt monster openly and through policy, not inaction and denial. Cutting welfare won't do it fast enough and generates many other problems. If we can't restructure our debts by agreement with creditors, we have to accept the "new normal": high unemployment, a reduced and distressed middle class and, perhaps, political instability barely restrained by greater authoritarianism.


(*) See today's post (with many graphs) by Michael David White, who thinks housing in America is only halfway through its correction.

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