Hoisington Investment Management’s Lacy Hunt recently spoke with CNBC’s Rick Santelli to talk about debt and Federal Reserve policy. Mr. Hunt warns that overall debt levels in the economy have grown far too large (as we discussed most recently here), resulting in slowing growth and financial risks. Meanwhile, tightening monetary policy during this period of economic weakness has led to contracting private sector credit growth (as we discussed most recently here).
“Your debt to GDP level is a bit higher than many, including the Fed. You have it at 370% of GDP on total debt. Can you explain how you arrive at that percentage Lacy?”
“Well, I include the the government sector, the state and local, the business sector, the household sector. I also include the foreign debt because a lot of foreign operations finance activities that tangentially impact the US economy and while some people would exclude the bank debt again there is heavy foreign lending overseas and so I look at the broadest debt levels that we have. However even my 370% is really not an adequate figure because this does not include off balance sheet items like leases which need to be included, and will be very shortly, and it of course does not include the unfunded liabilities of the pension plans in the private sector and the government sector. We have a very over-indebted economy and it is cutting heavily into our growth rates.”
“Federal reserve policy is biting very hard, much harder than is generally understood. The fed is tightening into a deteriorating economic situation. The nominal GDP growth rate which is our best measured series last year was the lowest rate of growth since the recession: only 2.9%. The economy is weakening further here in early 2017 and as a result of the Federal Reserve actions, we are seeing an outright contraction in the reserve aggregates as well as a rise in the short term rates that is beginning to cut into the demand for credit. We have actually seen a decline in bank lending over the last three months and its across all major categories of bank loans: the commercial and industrial, the commercial real-estate. Consumer loans are still rising but at a much slower pace. The money supply growth also is slowing very dramatically from about a 7% rate of growth last year to about 5 1/4% over the last three and six months. This is a very risky policy and we have to keep in mind that late stage tightenings by the Federal Reserve, and this is a very late stage expansion with exhausted pent up demand, have never worked well and I am afraid that the Fed is walking a very serious tight rope. Monetary policy is too restrictive for reasonable economic growth.”
This interview highlights the essences of the lose-lose situation that the US and many developed nations find themselves in, problems that we try shed light on here at The Sounding Line. Years of extremely accommodate monetary policy and low interest rates have led governments (the largest borrowers in the world) and pension funds to amass enormous quantities of debt and unfunded liabilities. Meanwhile, the absence of structural economic reform has kept the non-financial economy weak and the rate of household, consumer, and corporate debt growth low (albeit faster than the near zero economic growth). The result has been a surge in debt in relation to the size of the economy. Even the modest tightening actions undertaken by the Fed appear to be killing private sector debt growth and are likely to succeed only at raising the cost of servicing enormous government debts.
There does not appear to be a monetary solution to the corner central banks have painted themselves into. The only way to avoid calamity is serious economic reform: deregulation, tax reduction and simplification, and reductions in government spending. That may happen in the US. It doesn’t seem likely in Europe.
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