The Fed Convention – Give Me Liberty Or Give Me Debt!

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The Fed Convention – Give Me Liberty Or Give Me Debt!

The Fed Convention – Give Me Liberty Or Give Me Debt! by Danielle DiMartino Booth, Money Strong

In the event you’ve already binge-watched House of Cards Season Four, don’t be so quick to tune Netflix out. Instead, restore your faith in mankind and search for Brothers in War, a gripping National Geographic Vietnam War documentary that recounts the journey of Charlie Company. Though two-thirds of those who served in combat in Vietnam were volunteers, the draftees featured in Brothers were one of the last groups to go through basic training and sent to the front lines together, in this case to the unforgiving Mekong Delta. Some 50 years later in the making of this film, they reunite and marvel at their lasting bond. But most of all, these boys, now seniors, ask what gift of fate allowed them to return home at all, unlike so many of their comrades who made the ultimate sacrifice.

Among the unalienable rights generations of U.S. soldiers have fought to preserve is that of liberty, both ours and that of those in foreign lands. Little could many of those who served in the Vietnam era have known how terribly that very freedom for them as individuals would be impinged upon in their lifetimes. Among workers who are roughly the age of Vietnam veterans, 65 and older, those who work because they have to now exceed those working by choice by a factor of 2 to 1.

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Several culprits contributing to their delayed retirements are easily identifiable, chiefly being a lack of savings and income. But these are merely symptoms and don’t get at the root cause of the disease. At its contaminated core is a fundamental change in our culture which has for many, blocked the pathway to achieving the American Dream. That change is an acceptance of debt, rather than investment, to power economic growth.

Evidence of this transformation has shoved its way onto front pages in recent months. Fresh data out of the New York Federal Reserve show that debt among older Americans more than doubled in the 12 years ending 2015. Specifically, the average 65-year old has 47 percent more mortgage debt and 29 percent more auto debt than 65-year olds did in 2003. Over that same period, their labor force participation rate increased to over 19 percent from 13 percent, while that of the entire labor force went in the opposite direction.

As an aside, in the event the allure of a demographic explanation appeals, seniors’ increased debt loads are not directly attributable to longer life expectancy, though that argument would be convenient. The fact is, it’s difficult to retire when your savings have been ravaged and you’re shouldering more debt.

The shame of it is, it didn’t have to be this way. The economy could have been growing organically for the past 30 years in the same vein some of the world’s most successful companies have, from the inside out, by way of reinvestment. Granted, economic growth that stems from the disciplined redeployment of earnings is not as easy to maintain. But by the same token, it leads to far less violence in the business cycle.

Austrian economists refer to the serial boom and bust cycles spawned by prolonged periods of artificially low interest rates as malinvestment. How has this scourge manifested itself since the late 1980s, as today’s Wall Street came of age, with the birth of the Greenspan put? Without getting into the nitty gritty of each iteration, a whole heck of a lot of financialization took place, for lack of a more accepted existing term.

Financial institutions and capital markets worldwide came to dominate the economic landscape by lending into every nook and cranny regulators would knowingly or inadvertently allow credit to seep. Think of the numerous emerging market debt crises, Long Term Capital Management, the dotcom revolution, the commodities supercycle, the housing bubble and finally today’s mammoth credit bubble in its various forms.

In the case of the U.S. economy, the most damning conviction of malinvestment is productivity growth that’s threatening to flat line; it ended last year up 0.5 percent over the last three months of 2014. For comparative purposes, the 30-year average is 1.9 percent.

My former colleagues at The Liscio Report, Philippa Dunne and Doug Henwood, have done extensive work on the origins of declining productivity. They found the most obvious cause to be a lack of investment on companies’ part noting that at 6.0 percent of gross domestic product (GDP), equipment and software spending is below the 1950-2015 average. “The series seems to have topped out for this cycle at levels comparable to earlier recession lows,” they remarked.

Is it that companies are simply low on cash? Not hardly, they’re just directing that cash to share buybacks and buying each other out. “That may make some people happy for a while, but it doesn’t have the feel of a long-term strategy about it,” Dunne and Henwood observed. Indeed.

But there’s something much more subtle at work according to two recently published papers, both of which are footnoted at the bottom of this piece. The first paper links shifts in the composition of the workforce to credit booms and the financial crises that inevitably follow based on 21 episodes in advanced economies since 1969.

Not only does the temporary misallocation of investment do damage during the boom period – think of all those construction jobs that were created during the boom-boom days of the housing mania. The protracted, as opposed to plain vanilla, recessions that follow credit crises also act as a drag on underlying productivity. Income levels take appreciably longer to bounce back limiting both the ability to rebuild savings and splurge on that extra something without incurring even more debt.

The second paper examines the effects of startups, or a lack thereof, on productivity growth. The break in startup activity, such as that which accompanied the 2009 financial crisis, has left a lasting impact on GDP and productivity growth. While startup activity has recovered from its 2009 lows, it remains at the average level that prevailed prior to the crisis, from 1976-2007.

Looking back, Census Bureau data leave little doubt as to how much damage has been exacted as debt has unseated investment as the main driver of the U.S. economy. Newly formed firms represented as much as 16 percent of the total in the late 1970s; that share had declined to eight percent by 2011.

Bank for International Settlements Working Paper No. 534: Labour reallocation and productivity dynamics; financial causes, real consequences by Claudio Borio, Enisse Kharroubi, Christian Upper and Fabrizio Zampolli, December 2015.

The Federal Reserve Bank of Chicago: Firm Entry and Macroeconomic Dynamics: A State-level Analysis by François Gourio, Todd Messer, and Michael Siemer, January 2016.  

Household Debt

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Called "The Dallas Fed's Resident Soothsayer" by D Magazine, Danielle DiMartino Booth is sought after for her depth of knowledge on the economy and financial markets. She is a well-known speaker who can tailor her message to a myriad of audiences, once spending a week crossing the ocean to present to groups as diverse as the Portfolio Management Institute in Newport Beach, the Global Interdependence Center in London and the Four States Forestry Association in Texarkana. Danielle spent nine years as a Senior Financial Analyst with the Federal Reserve of Dallas and served as an Advisor on monetary policy to Dallas Federal Reserve President Richard W. Fisher until his retirement in March 2015. She researches, writes and speaks on the financial markets, focusing recently on the ramifications of credit issuance and how it has driven equity and real estate market valuations. Sounding an early warning about the housing bubble in the 2000s, Danielle makes bold predictions based on meticulous research and her unique perspective honed from years in central banking and on Wall Street. Danielle began her career in New York at Credit Suisse and Donaldson, Lufkin & Jenrette where she worked in the fixed income, public equity and private equity markets. Danielle earned her BBA as a College of Business Scholar at the University of Texas at San Antonio. She holds an MBA in Finance and International Business from the University of Texas at Austin and an MS in Journalism from Columbia University. Danielle resides in University Park, Texas, with her husband John and their four children. In addition to many volunteer hours spent at her children's schools, she serves on the Board of Management of the Park Cities YMCA.

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