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Four More Years of Obama: More Economic Malaise

By    |   Friday, 11 November 2011 08:47 AM

Deleveraging during the Great Depression took 14 years.
It may take just as long to right our economic ship if Obama is re-elected.

 In “Debt and Deleveraging: The Global Credit Bubble and US Economic Consequences,” McKinsey Global Institute (MGI), the business and economic arm of McKinsey & Company, examined 45 deleveraging cycles that occurred during the previous century.

According to MGI, the most highly leveraged sectors (i.e., high debt/income ratio) in mid-2009 were:

 1. Households: Canada, South Korea, Spain, UK, and US

2. Corporations: Spain

3. Commercial Real Estate: Spain, UK, and US

 In 2006, the financial sector was excessively leveraged in Switzerland, UK, and the US. Since then, they have deleveraged to a moderate level.

According to MGI, US debt/income in 1929 was 160%. By 1933, it reached 258% due to defaults (50% of urban mortgages), decreased income, and deflation due to restrictive monetary policy.

 By 1937, this figure fell nearly a third to 180%, as debt was paid and income increased. In 1943, this ratio fell further to 136%.

Today, total global debt is $180 trillion and total income is $60 trillion, a debt/income ratio of 300%.  A long-term, sustainable level for debt/income is under 200%.

 This is equivalent to the median family, with $50,000 of income, obtaining a $100,000 mortgage (100/50). Given the current 30-year mortgage interest rate of 4%-5%, the debt service as a percentage of disposable income would be close to 15%: certainly a sustainable level.

 Global savings can be used to pay down the debt. Annual global savings are roughly 20% of GDP, or $12 trillion. The debt repayment has a lower monetary multiplier associated with it, since it is not readily associated with long term, entrepreneurial endeavors that have long term potential.

 However, this methodology would be more propitious than divesting from owned assets, which total nearly $200 trillion worldwide. This divestment would increase asset supply and reduce asset price reductions, reducing economic velocity further.

 For each dollar in debt repayment, the associated increase in income is approximately $1.33 ($1.00 debt repayment plus $0.33 in associated expenditures by those receiving the dollar).

 Reducing the global debt/GDP ratio to 200% can be realized with a debt repayment of $15 trillion. This would generate nearly $20 trillion in income, reducing debt to $165 trillion, and raising income to $80 trillion (165/80 is approximately 200%).

Annual saving of $12 trillion can be used to pay down the debt and apportioned as follows:

1. $4 trillion: global unfunded liabilities (e.g., social insurance programs)

2. $6 trillion: global retained savings

3. $2 trillion:   debt repayment

 At this rate of repayment, deleveraging would be complete in roughly 8 years.

 However, this is not the end of the story.

 For the first time in 70 years, we are experiencing a break in the Beveridge Curve.

 This curve suggests the rate of unemployment falls as the percentage of job openings rise.  More job openings reflect an increase in demand for labor. This permits a market-centric pairing opportunity for applicants and employers, which typically reduces unemployment.

While, the percentage of job openings has recently increased, unemployment has not fallen a commensurate amount. This suggests our labor supply is ill-equipped to meet the current global demand.

This dynamic is a direct result of a poorly educated and inadequately trained labor pool over several decades.  Hence, economic growth may be slower following this deleveraging phase than it was after the Great Depression.

 The following are optimistic economic growth forecasts for the coming decade should Obama be reelected president:


 Time Period     Real GDP Growth Rate Description     Real GDP Growth Rate (% per annum)

1 - 3 years                           Anemic                                                         0 to 2

3 - 5 years                   Anemic to Moderate                                               1 – 3

5 - 10 years                       Moderate                                                         2 - 4

A deviation from these forecasts may result from politically initiated fiscal and/or monetary policies. These interventions may have short term impact, but typically lead to medium term over-corrections.

 It took 40 years for us to arrive at this economic juncture: it may take a decade or two to untangle the resultant financial web.

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Deleveraging during the Great Depression took 14 years. It may take just as long to right our economic ship if Obama is re-elected. In Debt and Deleveraging: The Global Credit Bubble and US Economic Consequences, McKinsey Global Institute (MGI), the business and economic...
Friday, 11 November 2011 08:47 AM
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