Debt reduction is a fact of life for the United States. We are going to have to reduce our debts and that should spur the economy into high gear. Maybe. It’s clear that the deleveraging of our debts is close to an end and the theory is that all that leverage caused the slow recovery.
However, now that we are clearing all the debts, not all the forecasts are rosy. Not everybody is convinced that just by deleveraging our debts we will boost our economy, which means that if our economy doesn’t jump by leaps and bounds, the cause of the recession was much more deeply seeded.
A recent Morgan Stanley study on debt reduction found:
• From the last quarter of 2007 to the last quarter of 2013, the debt of U.S. households dropped $638 billion to $13.8 trillion. All the decline occurred in home mortgages (down $1.2 trillion over the same period). Still, credit card debt grew slowly. Moreover, much of the debt — led by mortgages — has been refinanced at low interest rates, says Morgan Stanley. As a result, consumer debt payments as a share of disposable income have dropped to levels not seen since the early 1980s.
• The debt of major nonfinancial corporations (excluding banks, insurance companies and other financial firms) hasn’t decreased but has been refinanced at lower rates. Companies are less burdened by debt service. At the depth of the financial crisis in 2009, corporations had about $1.50 of cash flow for every $1 of interest payments they owed. Now the ratio is about $3.50-to-$1. Debt maturities have also lengthened. Stronger cash positions and longer maturities make firms less vulnerable if short-term loans aren’t renewed.
• Financial firms have reduced leverage. At the end of 2007, their debts equaled about 110 percent of the economy, or gross domestic product (GDP). At the end of 2013, their debts had fallen to nearly 80 percent of GDP. (Financial firms tend to borrow at one interest rate and hope to earn a slightly higher rate when those funds are lent out or invested.) Banks also have more shareholder capital to absorb losses.
In the meantime, Paul Ryan (R-Wis) has crafted another budget for 2015 which would incur a debt reduction of $5 trillion over 10 years and would balance our budget by the end of the 10 year plan leaving us a financial growth of $5 billion in 2024. However, the Ryan debt reduction plan relies on cuts to welfare and other public entitlement plans to achieve this goal which will be a hard sell in the Senate.
Democrats see the debt reduction plan by Paul Ryan as an economy killer and the debate begins again setting up a perfect hot button issue for 2016. Challenging Ryan’s implication that our citizens who are unemployed are lazy is Democratic Senator Elizabeth Warren. Warren would rather shift the blame for the slow economic recovery to Wall Street, government deregulation of banking laws, and the no-strings-attached bailout of our biggest banks.
No matter what side of the argument you sit on, one thing is certain, a valued argument for 2016 is debt reduction.