In 2001, Alan Greenspan reminded us that he has "long argued that paying down the national debt is beneficial for the economy: It keeps interest rates lower than they otherwise would be and frees savings to finance increases in the capital stock, thereby boosting productivity and real incomes."
D'oh! We didn't listen. National debt was around $5.6 trillion when Greenspan gave his speech. Today it's quickly hurtling toward $11 trillion.
But, hold on ... maybe we did listen? Low interest rates ... no, insanely low interest rates, were the norm from 2001 until around 2005. And, by golly, we sure didn't have any problem financing increases in capital stock. Add in the windfall from real estate, and real incomes couldn't find a ceiling. Labor productivity grew at its fastest rate in decades, too. Where'd the Maestro go wrong on this one?
Nowhere, really. Under normal economic conditions, he would have been spot-on. Interest rates would have surged. The cost of borrowing would have been prohibitively high. Real incomes would have plunged. Productivity would have wallowed. Alas, the sequence of events that fueled the past decade was anything but normal.
Cleanup on aisle "huh?"
Right now, things are ugly. General Motors (NYSE: GM ) and Ford (NYSE: F ) are staring the unimaginable in the face. Poor Starbucks (Nasdaq: SBUX ) has shed two-thirds of its value since last spring. Circuit City called it quits last week. Consumer spending isn't looking good for Santa this holiday season.
But none of that is directly related to subprime mortgages, CDOs, credit default swaps, or Tier 1 capital. It's part of the "seismic shift" plaguing the economy that Best Buy (NYSE: BBY ) warned of last week.
What are we shifting away from? A lot of things, but one of the biggies is a fierce economic cycle that fueled the past decade. It went something like this:
- We needed ultra-low interest rates after 9/11.
- Those low rates fed insatiable demand for housing (real estate was especially attractive, because investors' fingers had just been burned by the dot-com bubble, so stocks were taboo).
- Rising home values led to a surge in consumer spending -- funded by debt, of course.
- Spending sprees led to massive trade deficits.
- Massive trade deficits led to massive capital inflows by foreign investors.
- Massive capital inflows kept interest rates low.
- Hey, hey ... low interest rates? We're back to square one!
- Repeat cycle until wealthy.
That self-reinforcing behavior carried us through the highs of last year. And, man, wasn't it good? Tiffany (NYSE: TIF ) could hardly keep its display cases stocked. Homebuilders like Toll Brothers (NYSE: TOL ) and Beazer (NYSE: BZH ) could build without giving much thought about demand. Like any other bubble, people used phrases like "the new economy," chalking it up as globalization at its finest. The world lent. We spent. No one complained. Provided each party did its fair share of lending and spending, there wasn't much that could slow the cycle down.
That's when we had our Minsky moment.
Have a seat, Dr. Minsky will see you in a moment
A Minsky moment is a phenomenon named after economist Hyman Minsky, which describes what happens when an economy simply can't afford its debt anymore. Think of it in Wile E. Coyote terms: We reach the Minsky moment when, suspended in midair, we realize we've outrun our road, look down, and panic. The dangerous part isn't just that debt becomes a pain in the rear, but that it'll cause our half of the aforementioned cycle to grind to a halt.
That's where it gets ugly. When we can't come through on our half of the deal, things might start to spin in reverse. Events could go something like this:
- Lower home and stock prices leads to less consumer spending.
- Less consumer spending leads to smaller trade deficits.
- Smaller trade deficits lead to less foreign capital inflows.
- Less foreign capital inflows lead to higher interest rates.
- Higher interest rates cause property and stock values to plunge.
- Plunging values leads to less consumer spending.
- Less consumer spending ... haven't we been here before?
- Repeat cycle until broke.
That's one of the biggest threats to our economy today: the possibility of being sucked into another self-reinforcing cycle like we were in the past last decade. Only this time, it'll drive us unreasonably poorer, rather than unreasonably richer.
How bad will it get? No one knows, but when you think that the first cycle took trillions of dollars in leverage and nearly a decade to break, the thought of something as severe happening in reverse is pretty daunting.
Like Yogi Berra said, "The future ain't what it used to be." That's kinda how I feel right now.