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The Lasting Cost of Debt
20 September 2011

Currently, total federal debt stands at $14.7 trillion, or around 98 percent of gross domestic product (GDP).

Federal debt financed by private investors, as opposed to held by government agencies, is about $10 trillion, or 67 percent of GDP.

In 2010, the net interest on the federal debt amounted to $196 billion.

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It doesn't seem consumer spending will pick-up soon:

First drop in household wealth in a year; stocks, home values dip; businesses hold more cash
September 16, 2011
Associated Press

Americans’ wealth declined this spring for the first time in a year, as stocks and home values fell. (And) corporations increased the size of their cash stockpiles.

The combination could slow an already weak economy because it implies that families have less to spend and businesses are reluctant to expand.

Household net worth dropped 0.3 percent to $58.5 trillion in the April-June quarter.

Consumers are already struggling with high unemployment and meager pay raises.

When people feel poorer, they spend less. That slows growth. Businesses then respond by cutting back on hiring and expansion plans. It can become a cycle.

Net worth is expected to fall even further in the July-September quarter because stocks plunged in late July and early August.

The S&P index has tumbled 11 percent since its April 29 peak, and 8 percent since the end of the quarter. That likely means an even larger drop in household net worth in the July-September quarter.

The likely drop in wealth comes at the same time that incomes are stagnating, particularly for middle-income households.

The report found household debt declined at an annual rate of 0.6 percent from the previous quarter, helped by a big decline in mortgage debt, which has fallen for nine straight quarters.

But the decline is deceiving. Mortgage debt is coming down because so many Americans are defaulting on payments and losing their homes to foreclosure, not just because people are paying off loans.

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We missed the opportunity for a V-shaped recovery in early 2009.

A significant tax cut, e.g. $5,000 per worker (or $750 billion for the 150 million workers at the time) would've jolted the economy into a virtuous cycle of consumption-employment.

Households would've paid-down or paid-off their highest interest rate debt to increase their monthly incomes and spending, and the banking system would've been strengthened.

Now, we need to cut government spending, cut taxes, deregulate, and overhaul government (i.e. increase efficiency) to spur growth.

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Here's what I wrote on Feb 2, 2009 (a $5,000 tax cut would've been better):

How to prevent an economic contraction in 2009 (currently, roughly a 2% contraction is projected in 2009):

1. Obama should change his stimulus plan to a $2,000 tax cut per worker (in the form of a tax holiday), along with increasing unemployment benefits by a similar amount. This will help households strengthen their balance sheets, i.e. catch-up on bills, pay-down debt, increase saving, spur consumption of assets and goods, etc. This plan will have an immediate and powerful effect to stimulate the economy. When excess assets and goods clear the market, production will increase.

2. Shift "toxic" assets into a "bad bank." The government should pay premiums for toxic assets to recapitalize the banking industry and eliminate the systemic problem caused by global imbalances. The Fed has the power to create money out of thin air, to generate nominal growth, boost "animal spirits," and inflate toxic assets.

3. Government expenditures should play a small role in the economic recovery. For example, instead of loans for the auto industry, the government should buy autos and give them away to government employees (e.g. a fringe benefit). So, automakers can continue to produce, instead of shutting down their plants for a month. Auto producers should take advantage of lower costs for raw materials and energy, and generate a multiplier effect in related industries.

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Inflation is low, because real growth has been slow.

However, long-term unemployment, government destruction of capital, depleting commodities, including oil, etc. will constrain real growth through inflation.

A fast recovery is more inflationary now than three years ago.

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We need to encourage capitalism and entrepreneurship, e.g. through reducing risk by deregulating.

Therefore, it'll be easier to start and expand small businesses, create capital, increase the quantity and quality of goods, and reduce prices.