Chart 2
Positive Economic Commentary
How Do You Spell Debt Relief? I-N-F-L-A-T-I-O-N
December 21, 2001
The economic party in the US is over. Fed Chairman Greenspan was negligent in his chaperoning duties at the party. He did not take away the punchbowl spiked with cheap credit in time. Now our nation has a huge debt hangover. How does a nation get temporary relief from a debt hangover? Unlike Argentina, if it is lucky enough to have its debt denominated in its own currency, it gets its central bank to oversee the creation of a lot more of its currency (including bank deposits). Additional quantities of the currency will, with a lag, increase inflation. Higher inflation will relieve the "real" burden of debt. Fears of deflation in the US are misguided. The focus should be on the threat of inflation. Fed Chairman Greenspan is a student of history if he is anything. He knows the history of the Great US Depression of the 1930s and the still ongoing Not-Quite-As-"Great" Japanese Depression, which started in the 1990s. He knows that in both cases, the central banks in question were unable or unwilling to "print" enough money to prevent a deflation that devastated debtors. So long as Greenspan has a basis point of fed funds rate to cut, he will not abandon US debtors.
Let's go to the charts. What do US private sector balance sheets look like in the aftermath of the just past economic party? Not good. As shown in Charts 1 and 2 below, debt as a percent of assets for both households and nonfinancial corporations is now at its highest level in the post-World War II era.
Chart 2
Up until about 1980, neither lenders nor borrowers were we in relation to the rest of the world. But as the 1980s progressed, we became net debtors to the rest of the world, really getting intoxicated with foreign indebtedness in the party of the 1990s, as shown in
Chart 3. US foreign net indebtedness is now $2.59 trillion or 25.4% of nominal GDP. As Chart 4 shows, in 2000, our gross indebtedness to foreign entities equaled about 10% of our nominal capital stock in 2000 compared with a little less than 2% in 1980. And Chart 5 shows that we devoted 3.6% of our nominal GDP in 2000 to remittances of interest and dividends to foreigners compared with 1.5% in 1980. It's good to be the issuer of the world's reserve currency - until you abuse the privileges, that is.
Chart 4
Chart 5
Is Fed Chairman Greenspan doing his best to promote inflation? You betcha. Take a look at Chart 6. On a year-over-year basis, the M3 money supply was up 14% in November - the fastest M3 growth since the early 1970s. You remember the '70s - the Great Stagflation.
If debt relief is spelled I-N-F-L-A-T-I-O-N, relief is not imminent, right? I would say it will be on the way as soon as energy prices stabilize. As shown in Chart 7, this year's moderation in CPI inflation has come from falling energy prices. But for the second year in a row, CPI inflation excluding energy components has increased. With an economic recovery on track to commence in the first quarter of the New Year, energy prices will likely stabilize in the first half of next year. I look, therefore, for inflation to start rearing its head in the second half of 2002.
As I said at the outset, inflation provides only temporary relief for a debt hangover. At some point, markets will punish an economy whose central bank is promoting inflation. That's when the central bank has to not just pay lip service to fighting inflation, it has to take action. And that's when the debt hangover really gets nasty.
Paul Kasriel
Director of Economic Research
Note: The views expressed above are solely those of the author and do not necessarily reflect those of the investment divisions within The Northern Trust Corporation.
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