The fortunes of the captive insurance industry – those of its owners and sponsors particularly – ebb and flood with the flow of global political and economic currents. Current conditions provide plenty of concerns: the economic slowdown in China; India’s reluctance to curtail its bureaucracy; evolving nationalism and protectionism in the emerging world; a small Euro fiasco matter, and then, of course, there is the matter of America’s puzzling inability to face up to its vast accumulation of debt. It is with part of this latter issue that this brief note will concern itself.
So, why the American enigma? Well, in part, because our elites find it difficult to grasp that our economic foundations have become unsustainable. For more than 50 years now, the US has relied on a very successful “borrow, spend, grow, tax and repeat” model as its economic bedrock. The core engine of this model was the American consumer to the tune of consuming 70% of a GDP of more than $15trn.
That model is now broken and we are running out of time to fix it. Five years after the financial crisis, the US economy remains in a deep recession – actually, a euphemism for it feels more like a Depression. Resuscitating that consumer’s spending spirits remains critical, however, if the economy is to be revitalised. Unfortunately, the smelling salts aren’t working.
This presents a potential catastrophe in the waiting for all of us in the West.
Without any underlying base to its currency since the “Nixon shock” of 1971, the US has been unrestrainedly careless with its finances. It habitually spends much more than it takes in and it borrows the difference, expecting perpetual economic
growth to cover the gaps bridged by debt. Annual budget gaps of $1.5trn and more are not uncommon. Since the financial crisis, however, growth has been scarce. Moreover, many additional trillions have been pumped into the financial system to encourage lending. To pay for all of this debt, the US Federal Reserve and our financial institutions have engaged in an orgy of printed and electronic money and credit creation, in spite of warnings regarding potential hyperinflation.
The US government has borrowed more than $15.7trn with interest, roughly one-third of that within the last four years. Most of the money has gone into building an elaborate and wasteful Welfare State. State, county and municipal governments, local school districts and other public authorities have borrowed several hundred billions more, thus inviting severe budget problems and insolvencies upon themselves. The private business sector – itself no slouch – has borrowed more than $50trn. Consumers have borrowed more than $13trn – and it is the bottom 99% of Americans who now owe 95% of that total household debt.
Given the huge profit potential from money and credit manipulations, the US economy undertook a deliberate transition from producing goods and services of value and wealth to financialisation. There was simply more money to be made by joining
the financial bubble . No wonder assets bubbled, homes in particular; credit seemed unlimited; inflation, currency debasement and default were nothing to worry about. Laissez les bons temps rouler! Even the rich went out and borrowed – pardon me, leveraged – what they could.
So here we are, debt up to our eyeballs at every level of our society. The US economy kept pedaling harder and faster to keep up with debt payments, while still reinvesting in productive capacity. But how does one nourish sufficient consumer demand to enable growing faster than the debt? Well, through easy credit of course. Rather than rationing her consumption to savings and disposable income, the American consumer was encouraged to tap into borrowed money: credit cards, consumer loans, homeowners’ equity, exotic mortgages; buy now – pay later. That same consumer has now gone AWOL – and that is why “borrow, spend, grow, tax and repeat” is broken.
How could it be otherwise? Five years into crisis and recession, unemployment sits at 8.2% – more than 13 million people with nothing to signal a near-term fundamental drop. More than 40% are six months or more out of a job. Include people who work full-time, not part-time and people who have given up looking for a job and the figure becomes 15%. The employment/ population ratio, traditionally over 65%, is now 58%. Inflation-adjusted wages haven’t increased in 50 years but executive pay has sky-rocketed to 350 times the average workers’ pay.
Social mobility – a deep-seated tenet of opportunity for life in America – is close to an all-time low. Geographic mobility is curtailed by high gas prices and by being unable (“few buyers”) or unwilling (“mortgage underwater”) to sell the home and move to where that rare job might be found. The average household’s disposable income is squeezed by interest payments and debt repayment, while the luxury of drawing down phantom homeowner equity for additional borrowings is no longer within the consumer’s purview. Homes are down an average of 40% or so. Home equity lines have been cut or discontinued. Yet mortgage amounts remain unchanged – unless defaulted or foreclosed, which in turn ruins future credit worthiness.
Family households with children – and there are close to 80 million of them in America – face the further burden of tuition increases of close to 500% since 1986 (115% for other goods) while student loans total more than $1trn. Any savings the household might have had have been utterly destroyed by the Federal Reserve’s “zero interest rate” policy or they have been cashed in to pay bills. The middle class, in other words, is getting killed. No wonder animal spirits have evaporated into thin air!
The economic policy response has been an utter failure. The Federal Reserve’s monopoly over the price of money has been ruinous. All links between pricing risk and return have been severed. Moral hazard and mismanagement reap the gains; the taxpayer pays the losses. Its policy of gorging the banks, much like Perigord ducks, with vast amounts of digital money in the hope of stimulating
lending has been entirely ineffective for no other reason than that of common sense: Lend to whom – even if the banks were willing to lend (which they are not)? Lend to the pitiful American consumer? Lend to business? There is no business without thriving, free-spending American consumer demand. For that, the consumer needs money in his pocket, not more debt !
The political response, on the other hand, has been a heavy dose of crony capitalism, with selective subsidies and bailouts to the politically favoured and well-connected. Neither response has been effective, except to the extent that many Americans now understand that the welfare state is a lie and an illusion and that big government is incompetent government. No amount of wishful thinking will provide the jobs, lifestyle, healthcare, retirement and financial security that a half-century of welfare statism promised. Americans – sovereign, business, and consumer alike – are relearning age-old lessons the hard way. Debt has real consequences; it has to be repaid, with interest; it is an obligatory non-discretionary item; interest rates go up as borrowings increase; and lenders stop lending when the music stops.
Because the old model worked for so long, it is now very difficult for some to think that its time may be up. But, as with our penniless consumer, our entire nation has now run out of real money. It is patently clear that the need for debt reduction and expense containment will constrain whatever else our political economy wishes to achieve. The promises and wish lists of the Welfare State have run square into their Lord Master: Debt. A new economic paradigm is needed. It’s not clear, however, what that will be: Inflate? Deflate? Debase? Default? Or, mirabile dictu, perhaps a real viable solution? Which will it be? That remains to be seen. But we are down to the wire. The triple witching hour is just about upon us: 1 January 2013, Fiscal Cliff Day – a day that may just live in infamy!