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Did Washington Save the Economy? Part 1


A "jobful" rebound is unlikely to goose the recovery.

What really happened was possibly something of an altogether different nature. During America's fabulous financial bubble era, payrolls ballooned by millions in response to surging demand for building tradesman, retail clerks, mortgage brokers, hospitality workers, architects, car salesmen, management consultants, gardeners, decorators, personal shoppers, and much more. But on the margin these were bubble jobs funded by the household sectors' ATM account, not its far lower, sustainable level of spendable earnings. Consequently, the peak nonfarm payroll of 138 million jobs in December 2007 has been severely winnowed over the past two years -- not in response to a temporary spat of bad psychology on Main Street, as the bulls would have it, but on account of a permanent liquidation of final demand commensurate with the ongoing shrinkage of household debt and discretionary spending.

Indeed, the more pertinent theory would be one focusing on the opposite idea -- that of the Phony Boom which occurred in the years before December 2007, not on the crash years that inevitably followed it. And the more apt prism for viewing Wall Street's recent trauma would be the possibility that Lehman wasn't a random accident that should have been prevented, but that it (and almost any one of its competitors) was an accident destined to happen, the straw on the camel's back that finally brought down a 30-year super-cycle of reckless and unsustainable debt expansion.

There's a graph currently making the rounds that's dramatically on point. It shows the US economy's long-term leverage trend, measured as the ratio of combined public and private debt to GDP. You can draw a bright-lined box -- bounded on the vertical axis by the years 1870 and 1980 and on the horizontal by a lower and upper debt-to-GDP ratio of 140% and 190%, respectively. Save for an aberration around 1933 when the ratio soared due to the fact that Depression-era money GDP plummeted from $100 billion to $50 billion in four years, the actual US leverage ratio stayed within the box for more than a century -- notwithstanding numerous cycles of war and peace, boom and bust. Then, beginning in the early 1980s, the economy's leverage ratio staged a breakout, with the graph going parabolic right through the events of September 2008. Under the weight of Promethean Federal debt issuance since then, the ratio has continued to climb, even as some $1 trillion in private debt has been liquidated. Now perched at 370%, the economy's total leverage ratio is extended far above all previous history.

During its century in the historical leverage box, of course, America's economy performed tolerably well, expanding by several orders of magnitude. But it apparently left untold riches on the table because on average it only carried 1.7 turns of debt compared with today's 3.7 turns. Yet if the bulls are right and nothing is broken, the two extra turns of debt that our forefathers forswore on account of prudence needs be chalked off to economic superstition, instead. Indeed, had yesteryear's policy makers known that the financial gods bore no animus against excessive debt, they could have piled it high decades sooner, pulling undreamed-of future wealth into their own present.
No positions in stocks mentioned.

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