The U.S. is leading most of its major trading partners in burrowing out of the mountain of private sector debt that nearly destroyed the global economy and is still retarding the economic recovery, a new report says.
However, while the private sector deleveraging is well underway, the renewal of robust global growth will depend on a credible long-term plan for reducing the government’s share of total national debt that continues to mount, the report said.
Those conclusions echo recommendations repeatedly offered by Federal Reserve Board chairman Benjamin Bernanke before various Congressional oversight committees and during his biannual reports on the state of the economy. Former Fed chief Paul Volcker last week added his voice to the chorus saying the most pressing issue facing U.S. lawmakers is the need to enact a long-term plan for reducing fiscal imbalances that avoids an immediate sharp contraction in government spending.
Under current law, at the end of this year all the Bush-era tax cuts will expire and the government will slash more than $1 trillion from domestic and military spending. The Congressional Budget Office in January projected those tax increases and budget cuts would slow economic growth to slightly above 1 percent next year – a near stall speed.
The economy grew at about a 3 percent rate in the fourth quarter with the government running about a $1-trillion-a-year deficit. Republicans blame high spending for the deficits, while Democrats say the shortfall is largely driven by recession-induced counter-cyclical spending like unemployment insurance and food stamps and lower tax collections due to the payroll tax cut and high unemployment.
Either way, the new report from the McKinsey Global Institute showed that the mounting public debt has been more than made up for by declines in private sector debt, thus leading to about a 16-percentage point decline in total U.S. debt.
“We have a recovery worthy of the name . . . founded on the balance sheets of the private and public sectors,” Paul McCuilley, chairman of the Global Society of Fellows at the Global Interdependence Center, told an Atlantic Magazine forum on the economy this week. “My concern now is ‘Keynesian interruptus’.”
Total debt – comprised of loans to households, private businesses and banks, and government – is still rising in the world’s ten largest economies, the new analysis showed. But three of those countries, led by the U.S., are seeing their total debts as a share of gross domestic product finally starting to decline. The U.S. has seen three straight years of deleveraging in the wake of the 2008 worldwide financial crisis.
All of the declines in debt were in the private sector.
That’s a sharp change from 2000 to 2008, when total private and public debt in the U.S., when measured as a share of GDP, soared by 75 percentage points to about 300 percent. But it has since fallen by 16 percentage points, more than any other country. And it is still on the way down, entirely due to deleveraging in the household and business sectors.
Since the end of 2008, debt in the financial sector, which benefited from the massive government bailout enacted near the end of the Bush administration, fell by $1.9 trillion and now stands at 40 percent of GDP. Household debt, meanwhile, fell by $584 billion as millions of Americans hiked savings, reduced spending or saw their mortgage debts erased through foreclosure. Corporate borrowing also declined as a profit-fueled recovery enabled firms to pay down debt, the report said.
The report outlined six “markers of progress” that indicate an economy is on the mend from a debt-fueled financial crisis. They include a stabilized financial sector that has resumed lending; implementation of structural financial sector reforms; a government that has enacted a credible medium- and long-term debt reduction plan; growth in exports; and a private economy where private investment has resumed and the housing market has stabilized with renewed construction. The U.S. has achieved all but one of those six markers.
“Despite concerns over the strength of its recovery and the protracted debate over how to reduce public debt, the United States has reached more of these milestones than other nations and is closest to moving into the second, growth phase of deleveraging,” the report said. “Still, no country has all the conditions in place to revive growth.”
The U.S. now faces the most difficult phase of the deleveraging process: how to transition from reducing private sector debt to deleveraging in the public sector, where increased debt to this point has succeeded in keeping the economy from falling into a double-dip recession. After four years of heightened deficit spending, public debt in the U.S. stands at 80 percent of GDP, which is the highest level since the end of World War II.
“The next phase of deleveraging, in which the government begins reducing debt, will require difficult political choices that policy makers have thus far been unable to make,” the report noted.