Blessed are the young, for they shall inherit the national debt — Herbert Hoover
Considering the fact that Hoover presided over the early stages of the Great Depression, and has been generally considered one of the least effective presidents in U.S. history, those were prescient words.
Despite the relatively short-term periods of time in which the United States has been able to balance its own checkbook, the federal government has generally operated on the principles of deficit spending, in which expenditures exceed revenues.
As a result, gross public debt has grown over the last century, increasing markedly during recessionary periods.
Debt tends to spike during the early stages of a recession due to the combination of reduced net tax revenues, politically-expedient stimulus packages and increased fiscal policy designed to spark the US economy.
On the business and personal side, leveraging tends to be opportunistic, not reactionary. Both see the ability to increase wealth through asset acquisition, but frequently misjudge the potential returns of said investments.
Furthermore, they often fall prey to the misconception that higher leverage ratios are a transactional benefit, leaving little margin for error in either the net cash flow of the investment or its associative prospects for appreciation.
Unfortunately, the two work against one another in periods of economic uncertainty and, as such, can prolong the malaise.
Debt Reduction Imperative
Spending generates tax revenues, which fill the federal government’s coffers. However, since consumers and businesses only carry a small portion of their wealth in liquid resources, the majority of spending (whether in capital assets such as automobiles or real estate, or in lifestyle choices like vacations and possessions) during boom periods is financed. For this group, short-term debt such as credit cards being carried forward are prima facie evidence of deficit spending. Even during these periods, such debt should ideally be retired within 30 days after being incurred – however, during recessionary times, the uncertainty of income stability makes debt reduction imperative as a defense mechanism. With the same or fewer dollars to chase, the net result is lower discretionary income, and thus, lower spending.
Ironically, business and consumer deleveraging actually increases sovereign debt. For one, lower tax revenues from reduced income and spending generate budgetary deficits. Until the entity is able to reduce its budget, the gap between income and expenditures must be financed. Secondly, on the federal level, political considerations essentially force Keynesian-style stimulus efforts such as reducing taxes and/or increasing capital expenditures, which also require financing.
Spending vs. Savings – Which Comes First: Buying Chickens or Saving the Eggs?
The above conundrum is the classic push/pull scenario, in that by taking on the necessary and responsible task of reigning in spending, reducing debt and increasing savings, businesses and consumers are actually directly contributing to the worsening of the overall economy.
This phenomenon occurs on local and state levels as well, to lesser degrees. As a consumer-driven economy, the economic health of our society is directly and irrevocably tied to spending, which by definition lessens as dollars are diverted to other purposes, even fundamentally proper ones such as debt reduction and increased savings.
US Economy’s Great Recession: The End Game
This recession has trumped all others since the Great Depression by a country mile. The massive quantities of sovereign, business and consumer debt, in combination with unsustainable asset appreciation and government intervention, made for a perfect storm of events that transpired to increase both sides of the ledger in a massive “wealth grab” that spectacularly failed in 2008. Unfortunately, while deflationary forces took hold to dramatically reduce asset values, debt remained largely in place, drastically reducing overall wealth. The resulting spate of defaults and failures further exacerbated and prolonged the pain.
Recession: Benefits and Purpose
In the end, the weeding out of inefficiencies and inequities are the shadow benefits of recessions. Although they serve a similar metaphorical purpose to a controlled burn of an overgrown forest, and are just as indiscriminate and unattractive during the process, they are, without question, a periodic necessity. The dynamic tension between the two sides working in direct opposition to one another — retrenching consumers versus expanding governments — must resolve themselves before a healthy balance is reestablished and sustainable growth can resume.
Decoding Science. One article at a time.