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US debt, will it cause a new economic crisis? -3

by on 03/02/2018

Following the two previous essays about the US public and private debt data;

It’s time to look comprehensively at the debt problem of US and ask the question, can this debt cause a new financial crisis as it happened in 2008.

Modern economy is rather defined by its whole supply chain, than by its production facilities, which is part of it. A short description of supply chain system of a product introduction to the market would be as follows: The first stage is defining the product by exploring, surveying, planning done by visioners. When the planning process comes to the end, follows entrepreneurship done by business venturers, creativists, technologists, scientists, planners, etc., who manage the supply chain enterprise. They initiate a process of mapping the resources needed to create final product ready for sale, and distribute on the markets.

The supply chain in modern economy can be divided to four processes: Planning, Investment, Production and Distribution.

The cost in this supply chain system includes direct or indirect labour costs (including labour cost put in the raw materials and subcontractor suppliers), and capital costs in form of interest payments, rents, royalties, concessions and profit.

If profit is a cost out of expectation for reward, the visioners and entrepreneurs of the supply chain want to get as compensation for the risks they take in the whole process. Profit is also compensation for unique know how, self created by the visioners and supply chain process entrepreneurs.

Interest is paid for financial capital used for investment. Rent is paid for tangible and intangible assets in form of depreciation or lease fees, or as yield based on the assets value to the property holders.

The risk is highest at the first stage of the planning, before the new product is introduced to the market by the supply chain, if compared to the risk of a product already introduced to the market. Most of the interest payments are binded costs, for liability created before the distribution of the product started, stage of planning and investment. Interest payments are also different from other costs, that can’t be easily stopped or reduced if the introduction of the product to the market fails.

Interest, relatively easily manipulated by the government, is used as price of the money, paid by the entreprise of the supply chain. It is a major tool used by the government to influence economic happenings.

Interest payments, as contrary to labour cost, that is evenly distributed upon the whole process of supply chain, is caused by activities mostly concentrated on the first stages of the supply chain, planning and investment, and less in the stage of actual production and distribution. So most of the interest payments are binded to activities that happened before the final act to introduce a certain product to the market. This is why interest cost is more risk carrier than labour cost.

On the other hand direct variable production-distribution costs are the skeleton of the economic system in the microeconomic level, since its derivative is the supply function, and its intersection with the demand function generates the price of the products in the market.

Assets value at market price and the future gross income are crucial to predict the level of financial vividity or financial stress the enterprise is in. The sum of all the supply chain enterprises in the economy, are the actual private share of the economy on the macro scale. This is the share of the economy, that will pay taxes to finance the public spending, and generates the national income, divided eventually to taxes, wages, profit, rent, yield, royalties, and interest. Out of taxes and insurance fees will be done the redistribution of the income among different individuals and social groupings.

The economic growth, that is result of investment-savings on the fiscal side of the GDP, has to have its own growth on the contra side of the monetary system. This additional need for money as a monetary tool to enable smooth, continuous circulation in the economy is supplied by the government’s deficit or reduced interest rate, that increases the velocity of the money circulation. If to keep stable the interest rate, the government deficit has to be equal to the economic growth plus the inflation.

On the other hand the inflation and interest rate strongly influence the distribution of income. Both these phenomena cause depletion of wealth and income of the savers, (mostly the wage and pension income based social groups), and enrich the borrowers, the businesses and the wealthy.

On the macroeconomic scale the private debt, is more sensitive to economic upheavals than the public debt. The debt exposure of private enterprises above sustainable level, even temporary ones, are the reason of bankruptcies. This is why commercial banks and also businesses approach to credit is very careful.

According to the analysis of the previous assay the private debt to the GDP of non financial businesses in US did not change significantly since 2008, and according to the chart below it was not influenced significantly by the 2008 financial crisis.

To my opinion it proves, that the non financial businesses were not over borrowed before 2008, and their present level of debt is also stable. Interestingly the corporate businesses behaved at 2008 like in the times of business as usual.

Not so the private householders and mainly mortgages dropped significantly, from 100% of the GDP to 80% of the GDP. This significant change in the private householders debt, shows rather the level of problems the householders had before 2008 than prove increased saving propensities of the US householders. If 80% level of householders debt is sustainable this is a question. Definitely the contemporary low interest rates helped to keep it at this level.

What about the public debt? Before the 2008 crisis the public debt was close to 60%. This public debt at this level exists since the nineties of the twenties century. Actually when it dropped close to 50% of the GDP at 2000 there was the crisis of bubble. So it couldn’t be the reason for the financial crisis of 2008. Then in the post crisis years until 2013 it increased close to 100% of the GDP.

This additional debt is translated to additional liquidity in the monetary system, yet there is no sign for outbreak of credit, debt or inflation. It seems the new regulations of the banking system, Basel III rules and maybe also the lesson the banks learned from the 2008 crisis, keeps the lid on the credit, and it seems to grow simultaneously and in parallel with the economic development.

If the volume of the debt is not the most probable trigger of the next financial crisis, what about the inflation and interest rate? Is it possible, that at the current low interest rates level the debt is sustainable, but not so with the future increase of the interest rate?

If no major disruptions in macroeconomic level, non financial businesses as described above, are in stable state, most probably due to their professional decision processes about credit. Not so the private households and the public sector. Households with approximately 16 trillion US debt, every one percent increase in interest rate means 160 billion dollars more interest expenses. For the government it is 200 billion US dollars out of 20 trillion US dollars. What interest rate increase can be kept without risk of crisis is not clear. Yet this increased income out of interest is transfer of money from borrowers to the lenders. Who are the major lenders? Definitely not the non financial businesses, but the private households savers.

The financial system is influenced not only by credit but also by savings and its stability. Are the savings stable?

Nonfinancial corporate businesses are holding less than 2.5 trillion US dollars financial deposits. The non-financial non-corporate businesses hold even less, about one trillion US dollars financial deposits, and less than six trillion US dollars, all together financial assets. Most of the corporate businesses financial assets are either investments abroad, trade receivables, or miscellaneous assets. These financial assets are used rather as financial turn over capital, needed to run the distribution chain process, than value holding assets.

As to private savings, significant part of them are pension funds, life insurances and other social security funds, about 24 trillion US dollars. Low interest rate deepens the actuarial deficit of these funds, and additional income to them can only partly help with this deficit, caused by demographic change as result of average life span increase. These funds when reaching liquidity problems in the future, most probably their liabilities to the savers will be transferred to the general productive public, by its universal intermediator, the government or national social security departments. These savings are stable.

Conclusion; ten years after the economic crisis of 2008, the major development was transfer of private households debts, to the public debts. Out of it, on the macroeconomic level the US economy seems to be much more stable than ten years ago. But there are some clouds on the sky. As a result of policy of quantitative easing, the public confidence in the existing financial system and its major tool, money, is deteriorating. Viz the events around cryptocurrencies, that makes the leaders of financial institutions rather nervous.

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