Creating an environment of easy and affordable debt to boost economic growth has been a strategy that has been pursued for many years now — and it’s one that has contributed to many of the misallocations of wealth in the economy; in the 21st century there have been three major securities-related expansions that have occurred as a result.
One: Technology & Internet
Loose Keynesian economic policy (interest rate influence that does not match the credit requirements of the economy) first allowed for a temporary cycle-of-expansion in the technology sector in the 1990s, based on increased margin and credit expansion. Desire for technology stocks led to rising stock prices and encouraged further demand for margin, credit, & stock purchases. Extrapolations were made by new technology companies and investors — based on the ephemeral benefits of loose economic policy — yet when a limit was reached in the skilled dot-com labor able to develop new ideas, the expansion moved to contraction and the realization was made that the extrapolations were incorrect.
Two: Real Estate
The Fed continued to ease policy (influence of interest rates lower) to deal with the negative economic consequences and sector/employment dislocations created by a dot-com collapse; this allowed speculative money to flow into the real estate market, raising real estate prices, and encouraging more debt based spending. The finance industry created products through a process of financialization to service the demand for real-estate investment and yield; the culmination of this expansionary episode was reached in 2007. Dr. Hyun Song Shin clearly characterized the cause of the second major economic crisis not as a spontaneous and unexplained event, but as a systemic problem that is allowed to build on itself over a period of years; at the 2013 Jackson Hole Monetary Conference he said, “Things were not right in the financial system before the crisis, leverage was too high, and the banking sector had become too large.”
Three: Reach for Yield and Experimental Monetary Policy
In response to a real-estate and stock-market collapse between 2007-2009 interest rates were influenced to near-zero levels — i.e. zero interest rate policy (ZIRP). After using up its ability to influence interest rates lower, the Fed moved to large scale asset purchases (LSAP) — also known as quantitative easing (QE) — in an attempt to boost the economy with an untested policy which was ineffectual and created even more significant distortions in the flow of capital (see Economic Constraints and Policy Options).
The U.S. stock market has trended higher since 2009, in correlation with LSAP, allowing the “Fed put” (Fed protects risk-assets) idea to pervade the finance industry; this has allowed a tendency to persist in attributing LSAP as the reason for the end of the recession and stock market sell-off in 2009. However, the more likely source of the stock market recovery in 2009 was the suspension of mark-to-market accounting, allowing significant leniency in the pricing of securities — essentially allowing banks and other financial institutions to sidestep insolvency, as they no longer had to report the value of their securities using prevailing market prices. A suspension of mark-to-market accounting, combined with zero interest-rate policy (ZIRP), continued to allow financially irresponsible and inept institutions to remain functional, in disregard to the fundamental concepts of capitalism. Loose monetary policy has again created an environment where risk assets are priced for lower long-term returns and where yield-oriented investments are unable to give the returns that they have in the past.
Pulling Growth Forward
Loose Keynesian economic policy has allowed a significant amount of debt-based spending to occur in an attempt to pursue near term growth, but the debt has been used by the vast majority of the population to subsidize stagnating and falling incomes; this has now effectively created a very small creditor population, and a very large debtor population holding excessive mortgage, credit card, and student loan debt. Stagnating income levels, ZIRP, and excessive debt have also caused seniors to remain in the workforce longer — an attempt to make up for years of income stagnation and low yields. The lack of a safe exit from the work force for older workers effectively prevents some advancement for each successive generational group, culminating with a somewhat blocked entry into the workforce for new graduates. High debt levels for younger individuals effectively inhibits events such as first home purchases, the formation of new families, and birth rates, causing a downward pull on economic growth.
Fed policy has pursued short-term economic growth(at the expense of the long-term), and stock market gains in the form of debt-based spending, in an attempt to alleviate economic stress caused by needed structural changes. By not allowing a lack of demand for services, goods, and entire industries to clear away antiquated products and industries, necessary structural changes are not allowed to be made. The Fed is attempting to pull spending forward, yet by allowing those industries that would otherwise not be in demand to flourish, they are allowing raw materials to be used up, and are preventing the labor force from being pushed to develop new/necessary industries and applying their faculties to their new positions; this — combined with the efforts of already entrenched industries to lobby further entrenchment through massive political contributions — effectively erects barriers to competition, suppressing the technological advancements that result from competition.
Debt-based spending is one of the reasons the level of corporate profits to GDP is at its all-time high. As this begins to revert back to its mean, as it always historically has, it may be because consumer spending is unable to maintain its previous pace due to debt obligations.
Consumer deleveraging will likely be necessary to remove the burden of unproductive debts — those debts that do not create a stream of revenues large enough to repay principal and interest. Productive debt generates an income stream to repay principal plus interest. Consumer debt defaults and renegotiations are likely the result of excessive debt burdens.
Keynesian economic policy was able to push the economy out of recession, in the early 2000s and in 2007-2009, by encouraging debt-based spending through reductions in the Fed interest rate target. However, the next recession may be more severe because of high debt burdens, the Fed’s inability to influence interest rates any lower, and the inability of LSAP to affect the broader economy.