Buying for Time – The Global Debt Bubble

While Paul Krugman, the well-known economist who writes for the New York Times, made a recent recommendation that America’s debt load should not be the country’s main concern, another voice is speaking out that it must be a priority. David Stockman, the first budget chief for President Reagan, believes that it’s time for the country to get a handle on its debt.

A Global Problem

According to reports, global debt of all kinds has skyrocketed higher than 300 percent of the Gross Domestic Product or GDP. Meanwhile, the Federal Reserve is attempting to prevent deflation as the government continues to produce its cause, which is excessive debt. Extremely low interest rates are fueling government and business spending.

Today, people can buy cars and pay little to no interest for them. In addition, since the 2008 housing mess is in the rearview mirror, mortgage terms are getting looser while corporations have been unwilling to miss out on cheap money. Many of them are taking on debt to rebuy their own stock. When a company engages in this type of investment, it fails to participate in economic growth, but it does accumulate debt that has to be paid back.

Benefiting from Debt

According to David Stockman, those who were born during the baby boom era benefitted from the nation’s debt explosion. He said, “This created temporary but unsustainable economic prosperity and a financialization of the system through lower and lower interest rates, which brought about massive rewards but no real investments.” Stockman went on to say, “Almost everyone who has been in the market has benefited, but they didn’t earn it.”

Stockman refers to this explosion of debt as a “bubble finance system.” If the country is ever going to correct its finances, then it has to stop exploding the federal debt. Spending cuts combined with tax increases will work toward a correction. This may mean cuts to defense, social security and subsidies.

The Start of the Debt Bubble

After the 1987 stock market crash, the Federal Reserve started a journey that created the biggest debt bubble ever. The day following the crash, the Chairman of the Federal Reserve, Alan Greenspan, reported that the Fed would be prepared to provide whatever liquidity the banking system needed to prevent the 1987 crash from becoming a systemic financial crisis. More than 28 years ago, the Fed put was created. This particular put established a safety net for investors.

In 1998, the Federal Reserve concocted a bailout involving several different banks. It did this to protect a high profile hedge fund called Long Term Capital Management. This particular fund had $80 billion in assets, and its trades were going against it. Industry experts determined that the hedge fund was going to be wiped out in just a few days. The Federal Reserve intervened setting the stage for the hedge fund community to act recklessly without fear of reprisal. This moment shows why and how the country’s debt grew to the high levels that it’s at today.

Growing the Economy

To grow the economy and relieve the country’s debt, the Federal Reserve established Quantitative Easing, or QE4, and this lets the Fed buy mortgage backed securities as well as additional debt. QE4 encourages lending with low long-term interest rates. With the program in place, financial assets avoid a free fall. It is also the start of a six-year expansion that will wind up fueling even more debt.

From 2008 to 2015, the total debt in America grew from $30 trillion to $40 trillion while the global debt increased from $142 trillion in 2007 to $200 trillion in 2014. In addition, the total global debt in percentage terms of the GDP expanded from 269 percent during 2007 to 286 percent in 2014.

To prevent the global economy from deleveraging, central banks intervened. By doing so, the financial institutions were able to inspire more leverage, which stimulated growth. However, some in the industry believe that this was a shortsighted solution to the world’s financial crisis since this step merely saves the problem for tomorrow.

For 2015, the global economy’s strength was questioned when commodity prices crashed. China’s economic growth slowed down as did global trade. The European Sovereign Debt Crisis started to spread while leveraged loans and some corporate debt saw a decline in their value. The credit markets also started showing symptoms that the debt-fueled expansion was beginning to shatter.

Buying for Time

Rate cuts and QE4 may buy time, but they will only provide temporary relief. Instead, major fiscal policy modifications will be needed to correct the debt bubble in the U.S. When it comes to the global debt, other countries will need to follow suit. For more information about the global debt bubble, stop by the Personal Money Store site.

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