Why The Status-Quo Is Unsustainable: Interest and Debt (What Yellen Won't Tell You)

Tyler Durden's picture




 

Submitted by Charles Hugh-Smith of OfTwoMinds blog,

Even if the economy were growing at a faster pace, it wouldn't come close to offsetting the interest payments on our ever-expanding debt.

If you want to know why the Status Quo is unsustainable, just look at interest and debt. These are not difficult to understand: debt is a loan that must be paid back or discharged/written off and the loss absorbed by the lender. Interest is paid on the debt to compensate the owner of the money for the risk of loaning it to a borrower.

It's easy to see what's happening with debt and the real economy (as measured by GDP, gross domestic product): debt is skyrocketing while real growth is stagnant. Put another way--we have to create a ton of debt to get a pound of growth.

There is no other way to interpret this chart.


source: Acting Man

The Status Quo has only survived this crushing expansion of debt by dropping interest rates to historic lows. This is a chart of the yield on the 10-year Treasury bond, which reflects the extraordinary decline in interest rates over the past two decades.

The Federal Reserve has pegged rates at essentially 0% for years. That means the strategy of lowering interest rates to enable more debt has run out of oxygen: rates can't drop any lower, and so they can either stay at current levels or rise.

Near-zero interest rates for banks borrowing from the Fed doesn't mean conventional borrowers get near-zero rates: auto loans are around 4%, credit cards are still typically 16% to 25%, garden-variety student loans are around 8% and conventional mortgages are about 4.25% to 4.5% for 30-year fixed-rate home loans.

This decline in interest rates means households can borrow more money while paying the same amount in interest.

So the interest payment on a $30,000 car today is actually less than the payment on a $15,000 auto loan back in 2000.


source: The Born Again Debtor

The monthly payment on a $400,000 home mortgage is roughly the same as the payment at much higher rates on a $200,000 home loan 15 years ago.

So dropping the interest rates has enabled a broad-based expansion of debt across the entire economy. Notice how debt has exploded higher in every segment of the economy: household, finance, government, business.


source: The Born Again Debtor

The other half of the debt/interest rate equation is household income: if income is stagnant and declining, the household cannot afford to take on more debt and pay more interest. With real (adjusted for inflation) household income declining for all but the top 10%, households cannot take on more debt unless rates drop significantly.

Now that rates are at historic lows, there is no more room to lower rates further to enable more debt. That gambit has run its course.

Many financial pundits claim private debts can simply be transferred to the government and the problem goes away. Unfortunately, they're dead-wrong. As economist Michael Pettis explains, bad debt cannot simply be “socialized”:
 

Remember that the only way debt can be resolved is by assigning the losses, either during the period in which the losses occurred or during the subsequent amortization period. There is no other way to “resolve” bad debt – the loss must be assigned, today or tomorrow, to some sector of the economy. “Socializing” the debt, or transferring the debt from one entity to another, does not change this. 

There are three sectors to whom the cost can be assigned: households, businesses, or the government. 

Earlier losses are still unrecognized and hidden in the country’s various balance sheets. These losses will either be explicitly recognized or they will be implicitly amortized. The only interesting question, as I see it, is which sector will effectively be assigned the losses. This is a political question above all....

In other words, when marginal borrowers--households, students, businesses, local government agencies, etc.--start defaulting, the losses will have to be taken by somebody. This is true of every indebted nation: Japan, the European nations, China and the U.S.

The idea that we can transfer the debt to the government or central bank and the losses magically vanish is simply wrong.

Even if you drop interest rates, if debt keeps soaring the interest soon becomes crushing. Even at historically low rates, the interest on Federal debt will soon double. That means some other spending must be cut or taxes must be increased to pay the higher interest costs. Either action reduces spending and thus growth.

If rates actually normalize, i.e. rise back toward historic norms, interest payments could triple.


source: Federal Spending by the Numbers, 2013: Government Spending Trends in Graphics, Tables, and Key Points

Here's one way to understand how reliance on ever-expanding debt hollows out the economy. Let's say the average interest on the $60 trillion in total debt is 4%. (Recall that charge-offs for defaulted loans must be included as debt-related expenses. The interest paid to lenders is only one expense in the debt system; the other is the losses taken by lenders for defaulted credit card loans, mortgages, etc.)

That comes to $2.4 trillion annually.

Now take the $16 trillion U.S. economy and reckon that real growth in gross domestic product (GDP), even with questionable hedonic adjustments and understated inflation, is about 1.5% annually. That's an increase of $240 billion annually.

That means we're eating over $2 trillion every year of our real wealth, i.e. our seed corn, to support an ever-increasing mountain of debt. That is not sustainable. Even if the economy were growing at a faster pace, it wouldn't come close to offsetting the interest payments on our ever-expanding debt.
This leaves the entire Status Quo increasingly vulnerable to any sort of credit shock; either rising rates or a decline in the rate of debt expansion will cause the system to implode.

 

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Tue, 07/15/2014 - 11:47 | 4959274 Seasmoke
Seasmoke's picture

Can't they put all the bad debt into a rocketship and blast it into the Milky Way ??

Tue, 07/15/2014 - 11:56 | 4959310 StacksOnStacks
StacksOnStacks's picture

"Yes We Can!" - Barry O

Tue, 07/15/2014 - 11:57 | 4959324 Vampyroteuthis ...
Vampyroteuthis infernalis's picture

Standard Baby Boomer elitist crap. Spend money for themselves and cronies and screw everyone else including their own generation!

Tue, 07/15/2014 - 12:03 | 4959343 MillionDollarBonus_
MillionDollarBonus_'s picture

The middle class is the key to a prosperous economy; and one of the best ways to invest in the middle class is to invest in education.

From Wikipedia:

Members of the middle class belong to diverse groups which overlap with each other. Overall, middle-class persons, especially upper-middle-class individuals, are characterized by conceptualizing, creating and consulting. Thus, a college education is one of the main indicators of middle-class status. Largely attributed to the nature of middle-class occupations, middle class values tend to emphasize independence, adherence to intrinsic standards, valuing innovation and respecting non-conformity. Politically more active than other demographics, college educated middle class professionals are split between the two major parties.

Tue, 07/15/2014 - 12:06 | 4959363 Pladizow
Pladizow's picture

"Inflate or Die." - Richard Russell

Tue, 07/15/2014 - 13:01 | 4959554 FL_Conservative
FL_Conservative's picture

"Can't they put all the bad debt into a rocketship and blast it into the Milky Way ??"

 

Better to do that with all the bankers and lawyers.

 

And MDB, why not just give it all directly to the unions since it just passes through the system anyway?

Tue, 07/15/2014 - 14:07 | 4959782 TeethVillage88s
TeethVillage88s's picture

Exile the bankers

Uses less Fuel
saves Money
Provides opportunity to Confiscate their wealth
Provides opportunity to accidentally give them some noninfectious disease.

Tue, 07/15/2014 - 21:04 | 4961173 logicalman
logicalman's picture

Send 'em all to Fukushima.

Two benefits:

1. if they escape, they'll glow in the dark and be easy to round up.

2. They'll get a taste of the suffering they've inflicted on others for centuries.

 

Tue, 07/15/2014 - 23:35 | 4961584 Four chan
Four chan's picture

what, me worry? A. E. Neuman

Wed, 07/16/2014 - 10:47 | 4962579 RaceToTheBottom
RaceToTheBottom's picture

Why not send both into space: Both the Banksters and those that edumacate the banksters?  See how well Ivy grows in space?

Tue, 07/15/2014 - 12:13 | 4959392 Vampyroteuthis ...
Vampyroteuthis infernalis's picture

MDB, this is probably the first time I have ever agreed with one of your comments.

Tue, 07/15/2014 - 23:20 | 4961548 McCormick No. 9
McCormick No. 9's picture

 MDB is not one for subtle wordplay. I wonder what he thinks about the destruction of the middle c lass by mr. obama.

Tue, 07/15/2014 - 12:16 | 4959410 SunRise
SunRise's picture

Why talk in terms of class?

Tue, 07/15/2014 - 12:29 | 4959450 Eyeroller
Eyeroller's picture

Because that is how Barry and the Dems divide and conquer.

Never mind that it is their own policies that have made the poor poorer.

Just promise free stuff and call any opposed to you racist.

Tue, 07/15/2014 - 14:32 | 4959882 AnAnonymous
AnAnonymous's picture

Because that is the way 'americans' put them their things.

For 'americans', the group is all.

Tue, 07/15/2014 - 20:40 | 4961123 Hydesrevenge
Hydesrevenge's picture

Economically, if I think about it, the poor are the wge earners trying to sustain, the rich are comfortbale keeping their money, the middle class are the future rich creating wealth.

 

Tue, 07/15/2014 - 21:06 | 4961181 logicalman
logicalman's picture

Take a look at George Carlin on this subject.

http://www.youtube.com/watch?v=XdH38k0iUgI

Wed, 07/16/2014 - 08:42 | 4962149 andy_pandy
andy_pandy's picture

The only "wealth" the middle class create is a result of the blood sweat and tears of the "poor". There is no wealth creation aside from the ding und sich of perception; capitalism has morphed into cronyism and fascism, leeching off central banks in order to perpetuate the myth of class distinctions in an increasingly unequal world; the speeding train of technology, like a virus, will eventually need a driver that stops at all stations

Thu, 07/17/2014 - 20:15 | 4971087 TheRedScourge
TheRedScourge's picture

Considering that anyone who earns less than $120,000 a year in the US pays less income tax than their share of government expenses, neither the poor nor the middle class produce any wealth for the most part. And we all can be sure that spending your EBT balance isn't creating any wealth.

Tue, 07/15/2014 - 12:37 | 4959472 LynRobison
LynRobison's picture

Well MDB, while we are on the subject of good things that won't help this particular problem, let me observe that one of the best ways to avoid gum disease is to floss every day.

Unfortunately, neither daily flossing nor investing in education will service the debt and keep the system from collapsing. 

Tue, 07/15/2014 - 12:42 | 4959490 TheEndIsNear
TheEndIsNear's picture

Wikipedia is one of the most biased and horrible sources of information that exists. It always invariably adheres to government lies in all things and is no better than the MSM. If you doubt this, read for example what it says about the demolition of the three world trade center towers on 9/11 with explosives by mostly highly placed dual Israeli citizens within the US government with a little help from Mossad for the execution of their evil plan. There is no mention at all of the active nano-thermite particles in the powered concrete nor the molten steel in all three basements two weeks after the demolition for example. Who benefited most from the 9/11 false flag attack, both politically and financially?

 

Tue, 07/15/2014 - 14:14 | 4959815 TeethVillage88s
TeethVillage88s's picture

The Stupidity is beyond All Reason.

I can sort of get that Liberals have LGBT, Anti Gun, Progressive Agenda that is very intrusive and has infected the US Court Systems.

I can get that Elitist Judges in New York City Support Nazi or Stasi type "Police State" measures and that our Courts are favoring Wealthy Corporate Interests.

But This is a Bipartisan Plot that Supports Wealthy Interests, Wealthy Bankers, Wealthy Corporations... and no one knows how SICK these people can be.

Anyone that thinks voting either Republican or Democrat will solve anything is in Lala Land. Powerful people just want to stick it to poor people while hiring mercenaries and additional security Measures.

I'm pretty sure if our Spies turn against the Congress, our Judges, or the President, they will die in vehicle or airplane crashes.

Tue, 07/15/2014 - 21:07 | 4961185 oudinot
oudinot's picture

Wkipedia seems to be quite helpful until one uses it to research a topic one knows well.  In these cases it is wholly ineffective.  Hence, it is probably crap compared to other more scholarly sources lower down on the search list  but it is so easy to use.

Although I am reticient to agree that  Wikipedia is complicit in the cover up of 9/11,  I think it is broadly agreed that we do not have the 'real story' but to assert it was definitely Mossad , thermite etc., is but a theory until one can tease out the evidence.

Tue, 07/15/2014 - 21:13 | 4961198 El Vaquero
El Vaquero's picture

It depends on the topic with Wikipedia.  When it comes to giving a description of wildlife or plants or whatever, it is normally good if you're not trying to become an expert.  

Wed, 07/16/2014 - 03:35 | 4961854 potato
potato's picture

What about historical accounts, like ho chi minh trail or the Battle of the Bulge?

Wed, 07/16/2014 - 01:05 | 4961727 NaN
NaN's picture

So where can I find this unobtainium that makes steel molten for weeks without insulation or an energy source? Sounds better than Hydrogen fusion. Maybe black holes were involved.

Wed, 07/16/2014 - 08:58 | 4962176 Tall Tom
Tall Tom's picture

Unobtainium is synthesized from the transmutaion of Imaginarium.

 

Just imagine that you cannot obtain Imaginaruium and then it transmutes into Unobtanium. It is so simple of a process that children find it naturally.

 

Weren't you paying attention in your alchemo-quantummetaphysics class? Did you forget the basic principle of setting aside your disbelief?

Tue, 07/15/2014 - 13:02 | 4959570 orez65
orez65's picture

Dear MDB, regarding your latest brain fart:

"... one of the best ways to invest in the middle class is to invest in education"

If the investment was to educate engineers, scientists, plumbers, electricians, in other words, investment in skill development I would agree with you.

But the reality is that the "educational investement" is being wasted in "educating" political "scientists", lawyers, "economists", "liberal historians", f...ing basket weavers ...

The present "educational investment" has created a massive bubble in our schooling system and prevented needed reforms, for example not investing enough in computerized learning.

If your goal is to piss me off, you have succeeded. You are the poster boy or girl for liberal s..t heads. I despise all of you. You, and all like you, are naive, arrogant and totally and absolutely incompetent.

Hell is too good a place for you.

F..k you a.s h..e. 

Wed, 07/16/2014 - 03:23 | 4961840 Stranded Observer
Stranded Observer's picture

Ha!  I checked your account and see you signed up over 2 years ago.  Read the comments much?  MDB is an exquisite, eloquent, full time troll who draws all the newbies into vehement replies.  Those of us who know this regard him in high esteem for the entertainment value he/she provides for all you suckers.  It's all good.

Tue, 07/15/2014 - 13:08 | 4959599 Dollarmedes
Dollarmedes's picture

"The middle class is the key to a prosperous economy; and one of the best ways to invest in the middle class is to invest in education."

The middle class won't be able to create real wealth while the parasite class is there to steal it: government, big crony institutions, big law, and social justice warriors.

Get rid of the parasites, then get out of the way. The middle class will fix itself. (of course, the parasites won't do this because there's no opportunity for graft)

Tue, 07/15/2014 - 14:19 | 4959834 TeethVillage88s
TeethVillage88s's picture

Sweeping Reforms.

But does that mean:

-Military Coup
-Civil War
-Secession of States
-Secret hits Squads to Take out TBTF Bank Executives
-Nationalizing Banks, Industries & Big Corporations
-Using Anti-Trust Laws to Break up Powerful Corporations & their Rich Executives
-Exile of unwanted people termed "Undesirable"
-removing Banking Powers from Powerful People/Entities
-Outlawing Lobbying, Campaign Contributions & Shell Companies

Tue, 07/15/2014 - 14:02 | 4959768 TeethVillage88s
TeethVillage88s's picture

German Government spends a lot on Training it's workforce. It even pays for German Language Classes and partners with industry to transform factories to new tooling and trains the existing workforce to prevent job loses. New Energy Programs get 5 years Interest Free Loans for Start Ups to prove their technology and business model like in Bio-fuel or Alcohol Stills (Actually Brazil and many countries do this last one.

I am not saying there is a German Plot at work in the USA to "Ruin" our Technology and Workforce Skills. I'm not saying that Germany is Rising and the USA has lost most export markets except for Oil Refining and other Oil & Gas work. I'm not saying that Germany Enjoys a strong Economy due to a "De Facto Mercantilism". But it is true.

How about Flat 1% Student Loans and Caps on Usury in the USA. How about the US Government loaning itself money instead of Paying TBTF Private Banks after all... with our current Debt Levels 102% of GDP things are so bad we are in "Full Crisis Mode Already" and Need Reforms before IMF/WB/OECD/BIS and the ECB start financial downgrades and Strong Recommendations for Reforms.

Wed, 07/16/2014 - 03:31 | 4961848 John_Coltrane
John_Coltrane's picture

Germany is pretty cold and thus white in the most important way-culturally.  Work ethic, standards etc.  Canada also has this advantage.  In any statistical comparison between mono-cultures like Japan or Germany to our "diverse" culture, the darker elements of the population (think Detroit) must be separated first to see if any real differences exist (e.g. gun death statistics, average income levels, IQ).  I'm guessing there are none.  But politically correct types believe this type of thinking is racist and must be avoided despite the cognative dissonance that results (though they still cross over to the other side of the street when those with higher melanone skin levels approach).   Survival trumps political correctness, I'm guessing.

Wed, 07/16/2014 - 03:34 | 4961853 potato
potato's picture

Better blame poverty. Yes, they have smaller brains, but poverty also has a high incidence with crime.

Tue, 07/15/2014 - 20:34 | 4961100 Escrava Isaura
Escrava Isaura's picture

Million dollar...

Welcome back!

Wed, 07/16/2014 - 03:26 | 4961843 Stranded Observer
Stranded Observer's picture

Yep!  And look at all the newbies he caught.

Tue, 07/15/2014 - 20:46 | 4961137 ebworthen
ebworthen's picture

MDB said:  "...invest in education."

What for?  To work at Chili's or sell Life Insurance?

We'd all be better off if the FED would just send us each $3 Million tax free.

I'll buy a home, and tip well.

Wed, 07/16/2014 - 09:06 | 4962203 PT
PT's picture

"Investing" in an "education" can be a problem when there is no money left for capital acquisition or R & D.  I guess there's always borrowing.

 

Minsky moment =  [ (income + capital gains) < interest due ]

Or, as others say:

http://www.investopedia.com/terms/m/minskymoment.asp

For example an investor might borrow funds to invest while the market is in an upswing. If the market drops slightly, leveraged assets might not cover the debts taken to acquire them. Soon after, lenders start calling in their loans. Speculative assets are hard to sell, so investors start selling less speculative ones to take care of the loans being called in. The sale of these investments causes an overall decline in the market. At this point, the market is in a Minsky moment. The demand for liquidity might even force the country's central bank to intervene.

http://en.wikipedia.org/wiki/Hyman_Minsky

Minsky argued that a key mechanism that pushes an economy towards a crisis is the accumulation of debt by the non-government sector. He identified three types of borrowers that contribute to the accumulation of insolvent debt: hedge borrowers, speculative borrowers, and Ponzi borrowers.

The "hedge borrower" can make debt payments (covering interest and principal) from current cash flows from investments. For the "speculative borrower", the cash flow from investments can service the debt, i.e., cover the interest due, but the borrower must regularly roll over, or re-borrow, the principal. The "Ponzi borrower" (named for Charles Ponzi, see also Ponzi scheme) borrows based on the belief that the appreciation of the value of the asset will be sufficient to refinance the debt but could not make sufficient payments on interest or principal with the cash flow from investments; only the appreciating asset value can keep the Ponzi borrower afloat.

If the use of Ponzi finance is general enough in the financial system, then the inevitable disillusionment of the Ponzi borrower can cause the system to seize up: when the bubble pops, i.e., when the asset prices stop increasing, the speculative borrower can no longer refinance (roll over) the principal even if able to cover interest payments. As with a line of dominoes, collapse of the speculative borrowers can then bring down even hedge borrowers, who are unable to find loans despite the apparent soundness of the underlying investments.

Thu, 07/17/2014 - 20:09 | 4971052 TheRedScourge
TheRedScourge's picture

Guess they're not any smarter if they're more politically active and still split between the parties. If they had all sided with one maybe it would indicate that they've figured out which party is the best, but the fact that they are split means there isn't one, but that they've still failed to figure that out.

 

Yes, let's dump more money into education, because we need more Ph.Ds driving cabs getting undercut by high school dropouts using Uber.

Tue, 07/15/2014 - 13:13 | 4959612 RafterManFMJ
RafterManFMJ's picture

Can we not dig a series of holes around the debt, fill the holes with water and then freeze the water?

This will immobilize the debt until future generations can pay for it.

Tue, 07/15/2014 - 15:37 | 4960205 Professorlocknload
Professorlocknload's picture

Nah, better to do the PC thing and put it all in the recycle bin.

Tue, 07/15/2014 - 11:59 | 4959334 MillionDollarBonus_
MillionDollarBonus_'s picture

.

Tue, 07/15/2014 - 14:03 | 4959772 redd_green
redd_green's picture

!

Tue, 07/15/2014 - 20:32 | 4961093 o2sd
o2sd's picture

Probably your best comment ever. Keep up the good work.

 

Tue, 07/15/2014 - 11:59 | 4959337 Itchy and Scratchy
Itchy and Scratchy's picture

'Change You Can Believe In'

Tue, 07/15/2014 - 11:56 | 4959312 kliguy38
kliguy38's picture

Finally some common sense.....much better than what Grandma says

Tue, 07/15/2014 - 12:30 | 4959456 jaxville
jaxville's picture

Good Grief!  A story about excess debt and not one mention of fractional reserve banking? The vast majority of debt out there was created as money being loaned out with an interest obligation.  What we are seeing now is a credit based money system that has hit the wall. It has gone about as far as it can.  Any action taken to maintain the status quo will have to be increasingly dramatic but yield shorter lived gains.

  Options are very limited at this point.  The scoundrels behind our current system are preparing to roll out a new one that allows them to retain power and their ill-got gains. 

    Not a good time to have your savings locked into some currency. 

Wed, 07/16/2014 - 06:46 | 4961962 layman_please
layman_please's picture

i also wouldn't mention fractional reserve banking. it's just too unbelievable as a concept. so every time i'm confronting it, i make sure i'm not dreaming.

Tue, 07/15/2014 - 13:13 | 4959615 tarsubil
tarsubil's picture

Essentially, yes. Rates can't go any lower? Yellen said the same thing today. This is just like an addiction. Lines are meant to be crossed. Rules are made to be broken. We will see nominal negative rates.

Tue, 07/15/2014 - 21:49 | 4961311 Yes_Questions
Yes_Questions's picture

 

 

and then some...

 

Why exactly "can't" the FED write off debt?  It can create money to buy bad loans and simply write it off.

 

ITS THE FED!  It'll be there to reap from the taxpayers another day.  

 

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