Unwinding the leverage age

Commentary By Ron Beasley

David Brooks has an unlikely column today.  It's unlikely because he actually gets a lot of stuff right but when it comes to solutions he becomes the David Brooks we all know and love and gets it wrong. But first where he gets it right:

For about a generation, the U.S. surfed on a growing wave of debt. The ratio of debt-to-personal-disposable income was 55 percent in 1960. Since then, it has more than doubled, reaching 133 percent in 2007. Total credit market debt � throwing in corporate, financial and other borrowing � has risen apace, surging from 143 percent of G.D.P. in 1951 to 350 percent of G.D.P. last year.

Charts that mark these trends are truly horrifying. There is a steady level of debt through most of the 20th century, until the mid-1980s. Then there is a steep accelerating rise to today�s epic levels.

This rise in debt fueled a consumption binge. Consumption as a share of G.D.P. stood at around 62 percent in the mid-1960s, and rose to about 73 percent by 2008. The baby boomers enjoyed an incredible spending binge. Meanwhile the Chinese, Japanese and European economies became reliant on the overextended U.S. consumer. It couldn't�t last.

The leverage wave crashed last fall. Facing the possibility of systemic collapse, the government stepped in and replaced private borrowing with public borrowing. The Federal Reserve printed money at incredible rates, and federal spending ballooned. In 2007, the federal deficit was 1.2 percent of G.D.P. Two years later, it�s at 13 percent.

Of course what he fails to mention is that generation of debt began with the administration of St. Ronnie of Reagan and his destruction of the middle class.  The consumer dependent economy still required that people buy stuff but the middle class had less money.  The solution - lots of easy credit.  We had economic downturns  followed by smoke and mirrors recoveries fueled by debt.  The straw that broke the camels back was the Greenspan/Bush credit binge prior to the 2004 election that made it look like there was a recovery when there wasn't any.  It worked and Bush was reelected in 2004.

Brooks still on target here:

Americans aren�t borrowing the way they used to, but the accumulated debt is still there. Over the next many years, Americans will have to save more and borrow less. The American economy will have to transition from an economy based on consumption and imports to an economy with a greater balance of business investment and production. A country that has become accustomed to reasonably fast growth and frothy affluence will probably have to adjust to slower growth and less retail fizz.

The economic challenges will be hard. Reuven Glick and Kevin J. Lansing of the San Francisco Fed estimate that Americans will have to increase their household savings rate from 4 percent to 10 percent by 2018 to restore balance. That, they write, will produce �a near-term drag on overall economic activity.� Meanwhile, capital and labor will have to flow from sectors that depend on discretionary consumption to sectors based on research and investment.

But it�s the political challenges that will be most hellacious. Basically, everything that a politician might do to make voters happier in the near term will have horrible long-term consequences. Stimulate the economy too much now and you wind up with ruinous inflation down the road. Preserve failing companies and you wind up with Japanese stagnation. Cushion the decline in living standards with easy money now and you just move from a housing bubble to a commodities bubble.

The politicians will indeed be the problem.  How many politicians really think that a message of less is better will get them reelected.  There really aren't enough of us old hippies who know that things don't make you happier to elect anyone.  Of course telling really rich people they need to pay more taxes will be a problem as well.  That will require the admission that supply side economics was a fraud.

Here is where I think Brooks is wrong.

Third, they will have to refrain from doing anything that might further damage America�s fiscal position, which is extremely fragile. That means not passing a health care reform package unless it is really and truly paid for. That means forming a Social Security commission next year to tackle that entitlement problem.

Fourth, the political class is going to attempt the politically unthinkable. The U.S. is going to have to move toward a consumption tax, to discourage spending and encourage savings. There�s also a crying need for tax reform. As economist Douglas Holtz-Eakin points out, the tax code is rife with provisions that encourage leverage and discourage investment. The government will have to spend less on transfer payments and more on investments in science and infrastructure.

We don't need a consumption tax. If people don't have the disposable income and can't borrow they won't consume.  The main problem with Social Security for several years will be can the government pay back the money it has borrowed from the trust fund. Transfer payments to the states will continue to be necessary because the Grover Norquist Yacht Club Republicans have passed draconian state laws that make it impossible for the states to fund necessary services.  So the tax code should return to pre-Reagan percentages.  The little piggies will scream from their yachts and threaten to leave the country.  Don't let the door hit you in the ass on the way out.