Politics Unfiltered

[BrotherCane]

http://alibertarianfuture.com/big-govern...ct-senate/

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America Can’t Escape the Debt Vortex
Total obligations in the U.S. have hit 370% of GDP—and Trump seems intent on making matters worse.
By George Melloan
Updated March 10, 2017 12:46 p.m. ET
211 COMMENTS

The Federal Reserve’s point man on banking regulation, Daniel Tarullo, will step down as a Fed governor on April 5, long before his term expires in 2022. He may be getting out just in time—before President Trump enacts protectionist policies that would further roil the credit markets Mr. Tarullo and his fellow governors have already distorted.
Photo: Getty Images/iStockphoto

During Mr. Tarullo’s eight years at the Fed, the central bank has encouraged a massive accumulation of government, corporate and consumer debt. Credit bubbles usually pop at some point and the consequences aren’t pretty. The stock-market crash of 1929 followed a credit boom, and so did the crash of 2008. In both cases, Washington overreacted, producing a 10-year depression in the 1930s and a weak recovery after the 2009 recession.

Most commentators, including me, have blamed this new debt balloon on the easy credit produced by the Fed’s near-zero interest-rate targets since the 2008 crash. But we may have attributed too much power, and culpability, to the Fed.

Interest rates have also been held down by heavy global demand for U.S. dollar assets from big dollar earners like China and Japan. Foreign central banks boosted their holdings of Treasury bonds to $3 trillion in 2013, up from $1.2 trillion at the beginning of 2008, before leveling off in subsequent years. The rollover of those holdings has sustained steady foreign demand for Treasurys, keeping prices high and interest rates low.

But the Fed helped. Its three rounds of “quantitative easing”—effusions of newly created dollars—in roughly the same period (QE3 ended in October 2014) added a further $3.5 trillion in demand for Treasurys and for the troubled mortgage-backed securities issued by Fannie Mae and Freddie Mac. Cheap credit, and miserly yields on savings, pervaded the U.S. economy.

Through its bond purchases the Fed ballooned its holdings to the present $4.4 trillion. By law, the interest return on those securities goes back to the Treasury after the Fed deducts the considerable amount it spends on itself. With almost free credit, Washington nearly doubled the national debt in seven years. The annual federal deficit continues to hover between $500 billion and $1 trillion.

To avoid rampant inflation after putting all that new money into circulation, the Fed cleverly arranged for banks to lock up some $2 trillion in their reserve accounts at the central bank, paying them modest interest (now 0.5%) for their trouble. That has prevented the excess reserves from flooding into the economy in the form of cheap loans.

Lacy Hunt, an economist with Hoisington Investment, estimated at a recent conference held by Grant’s Interest Rate Observer that debt of all kinds in the U.S. now totals more than $69 trillion. That’s more than double the $30 trillion recorded by Fed statisticians as recently as 2000. If the Hunt figure is correct, then total debt is now about 370% of GDP, up from 294% in 2000.

But foreign demand for American debt is showing signs of weakness. China has traditionally used most of the dollars from its large trade surplus with the U.S. to buy Treasurys. But Beijing’s foreign-currency reserves are declining as business slows, the financial system grows more unstable, and capital flees the country. In January China’s reserves dropped below $3 trillion for the first time since 2011. Total dollar holdings by foreign central banks have fallen to around $2.8 trillion today from $3 trillion in late 2013.

Domestically, consumer credit outstanding fell sharply after the 2008 crash but began rising again in 2013. It is now up 29% from five years ago—and 16% not counting the blowout in government loans to students. The Fed’s latest survey of senior loan officers indicates that demand for mortgages is slackening and that the “quality” of auto and credit-card debt is shakier. This suggests that many consumers have maxed out their ability to borrow. The report also notes that banks are tightening their lending standards on credit cards and auto loans.

The famed 1930s economist Irving Fisher taught that a credit cycle ends when both lenders and borrowers pull in their horns, which is what may be happening now. He wrote that the end of a credit cycle signals a downward turn in the business cycle. If so, the current bull market in stocks is also at risk.

There isn’t much the Fed can do about this except make it worse. More direct bond buying—a fourth round of quantitative easing—would send the debt load up faster. Conversely, selling from the central bank’s bond portfolio would likely raise interest rates by causing the debt supply to exceed demand. The Fed’s monthly striptease about interest-rate targets, watched so excitedly by reporters and traders, is pretty much irrelevant to all this.

Nor is there much that Mr. Trump can do except make it worse. But he seems intent on that—threatening trade wars against America’s biggest trading partners. If the president blocks their ability to earn dollars, he diminishes their ability to bail us, and themselves, out of the global debt slough. The past decade of government and Fed profligacy is not his fault, but that still isn’t an argument for recklessness. If this ends in tears, Mr. Trump will get the blame.

Mr. Melloan, a former deputy editor of the Journal editorial page, is author of “When the New Deal Came to Town” (Threshold Editions, 2016).