This week marked a troubling milestone in the ongoing struggle of American households with debt. According to a report released by the Federal Reserve Bank of New York, total U.S. household debt surged to a staggering $12.84 trillion in the second quarter, reflecting a $552 billion increase over the past year.
This development represents the second consecutive record high in reported U.S. household debt. While some may see this as a noteworthy achievement, the implications are far more complex and concerning.
First, this resurgence in household debt has returned to an upward trajectory, reminiscent of the steady rise observed from the end of World War II until the Financial Crisis of 2008. Second, similarly to the S&P 500, record-high debt levels appear to be emerging with mechanical precision. But could this be mere coincidence?
More likely, the surge in debt is linked to the vast wave of central bank liquidity pumped into the financial system over the last decade, which has created a torrent of inexpensive credit. This phenomenon has inflated both stock prices and household debt.
However, it’s essential to remember that while stock market gains can evaporate rapidly, the burden of increased debt will ensnare borrowers long before it can be addressed.
To understand the source of this liquidity, consider the total combined assets of the Federal Reserve, the European Central Bank, and the Bank of Japan. A decade ago, these assets hovered around $4 trillion. Today, they exceed $13.8 trillion. Factoring in the People’s Bank of China, that total skyrockets to nearly $19 trillion.
A Disappointing Reality
Unsurprisingly, this record debt and stock market surge were part of a broader strategy. The astute economists at the Fed assured the public that their policies of cheap credit would usher in prosperity through something they termed the wealth effect. Yet, this reasoning has always eluded clarity.
According to the policy architects, the wealth effect occurs when asset values increase. As investment portfolios swell, consumers feel more financially secure, leading them to spend beyond their means—notably on unnecessary items—using credit. This uptick in consumer spending is presumed to stimulate the economy, promoting widespread wealth.
However, the reality of the past nine years tells a different tale. While the S&P 500 has soared by 270%, GDP has only climbed by 34%. Additionally, median household income has stagnated, barely moving for over two decades.
Indeed, while the stock market has thrived, consumers have fueled record debt. The economy, in contrast, has merely floundered. Thus, the anticipated wealth effect has turned out to be a colossal letdown.
To compound matters, the Fed is now signaling plans to normalize its balance sheet—at least, that’s what they’re stating. The recently released July FOMC minutes indicate a strong consensus for the Federal Reserve to begin shrinking its $4.5 trillion balance sheet “…relatively soon, barring significant adverse developments in the economy or financial markets.”
Here at the Economic Prism, we are closely monitoring the Fed’s upcoming quantitative tightening. We suspect that the unwinding process could be far more turbulent than the Fed suggests, and we harbor doubts about their ability to make meaningful reductions to their balance sheet without prompting further expansions due to unforeseen adverse circumstances.
Why There Will Be No Last-Minute Debt Ceiling Agreement
Consider the precarious position of the stock market, which seems primed for an unprecedented crash. Even amidst last week’s sell-off, the market has largely dismissed serious threats such as North Korea’s nuclear ambitions, civil unrest, and the retail sector’s downfall as mere blips on the radar. However, will it remain unscathed in the face of a burgeoning financial crisis?
As Congress enjoys its summer recess, a significant fiscal disorder looms, ready to confront them upon their return. According to Business Insider:
“The Treasury Department states that the debt ceiling, which caps the federal government’s total debt obligations, must be elevated by September 29. This deadline gives Congress a mere 12 working days to pass legislation for President Donald Trump’s approval.
“Failure to raise the ceiling could result in catastrophic repercussions for the federal government, the U.S. economy, and the global financial system. A breach would mean the government could no longer meet its existing obligations, potentially leading to a default on certain debts.
“Consequences of a default, according to a Treasury study, could include a collapse of the stock and bond markets, a downgrade of the U.S. credit rating—resulting in higher borrowing costs—and erosion of the country’s financial credibility.”
“Despite the potentially dire outcomes, confidence remains—but guarantees are absent—that Congress can unite disparate factions to reach an agreement on lifting the limit.”
Historically, Congress has managed to strike a deal at the last minute, having raised the debt ceiling 78 times in the past 57 years. So, will they not be able to do so once again?
This time, however, we harbor significant reservations. This Congress has demonstrated a troubling lack of resolve to act in the best interests of the American people. Each representative seems to operate on an unpredictable logic. Just look at John McCain—he often appears uncertain of his stance until the moment he casts his vote.
Moreover, the debt ceiling issue has become excessively politicized, necessitating extensive horse trading before an agreement can be brokered. Additionally, considerable posturing and grandstanding have become the norm.
The reality is that over the past six months, Congress has struggled to accomplish even basic tasks. What leads us to believe they can muster the resolve to act effectively in just 12 days?
Sincerely,
MN Gordon
for Economic Prism
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