Debt reduction is now the real story of the American economy, just as real story behind the apparent free lunch of the last two decades was rising debt. The secret that has completely eluded Bernanke is that aggregate demand is the sum of GDP plus the change in debt. So when debt is rising demand exceeds what it could be on the basis of earned incomes alone, and when debt is falling the opposite happens.
Ding ding ding ding.
The entire mantra of "private debt doesn't matter" is of course idiotic, but it forms the premise upon which Krugman, Bernanke and many others try to labor. Worse, some of them go a step further and say that government debt doesn't matter. This is how you get charts that look like this:
But of course as anyone who has ever been up to their eyeballs in debt knows, it most certainly does matter, because the amount of debt you can carry is finite - no matter who (or what) you are.
So as debt level rises your ability to keep taking more goes down. That debt adds to aggregate demand just as would more income. But when that debt accumulation ceases, so does the demand that it sponsored, and when it reverses you wind up subtracting from demand that which goes to pay off the debt!
Of course there are those who argue "but one man's debt is another man's asset", and I'd agree with this - if all debt was paid. But defaulted debt is another matter, isn't it? Now what's that "asset" worth? Oops.
The other issue, which none of these people (except Keen!) seems to appreciate is that when you're up to your eyeballs in debt your production is inevitably shifted away from productive and saving pursuits. The first is a problem. The second is corrosive to industry, as it is savings that form the predicate for Capital Formation and it is Capital Formation that is the seed from which new businesses, and thus employment, grows.
That sucking sound will continue for many years, because the level of debt that was racked up under Bernanke’s watch, and that of his predecessor Alan Greenspan, was truly enormous. In the years from 1987, when Greenspan first rescued the financial system from its own follies, till 2009 when the US hit Peak Debt, the US private sector added $34 trillion in debt. Over the same period, the USA’s nominal GDP grew by a mere $9 trillion.
Yep. And guess what - now a good part of that $34 trillion has to come out. My "best guess" is about $25 trillion of it.
This will of course whack on GDP - probably by 40% and perhaps more. That takes us back to $10 trillion.
I've been arguing this for three years now in these pages. The exact amount of damage to GDP and debt that must be excised in order to bring the system back into balance is a point of contention, but that this has to happen, as the Ponzi has hit the wall, is not. That is a mathematical certainty.
The sooner we take our medicine the better.