Posted on 07/07/2003 10:02:35 AM PDT by Steven W.
In 1991 the gurus saw a below-average decade ahead because the prior decade had been too good. They were wrong. They're wrong about the next decade, too.
Supporting most bears right now is a bunch of bull: namely, the notion that too much debt will bite us in the butt. Ever since last fall the guts underlying gloom-and-doom market forecasts have been disproven, one by one.
Excessive debt is the main argument that the bears still hug. Which is one reason the bull market has a long way to run; the bears are basing their case on a wrong argument. Debt doomers come in varying styles. There is the banking-crisis style and the real-estate-implosion style--often linked, as in "falling real estate prices will bankrupt the banks, which will cause chaos." Then, too, are those noting the "tapped-out consumer," who can't or won't borrow more--thereby causing an anemic recovery, or no recovery; or, finally, the pseudo-sophisticate's favorite--the double "dip" recession.
Don't get me wrong. I don't recommend going into debt. Personally, I owe virtually no money. Certainly there are individuals, firms, industries and municipalities that are too heavily and stupidly leveraged and will pay for it dearly (as is always true).
However, in aggregate, debt levels won't hurt the economy or the stock market in the 1990s.
No, that "1990s" isn't a typo. The four paragraphs above were the beginning of my Aug. 5, 1991 column, entitled "Dumb Bears." With this issue, as I start my 20th year as a FORBES columnist, I reach back 12 years to steal my own material, word for word--because so much of what I said about 1991 and 1992 plays well in 2003 and will in 2004. From a handful of those 1991-1992 columns I could lift paragraph after paragraph, and, with no more than the insertion of contemporary dates, they could serve for analysis of the here and now.
For your amusement, let me continue from the August 1991 column:
And the tapped-out consumer? Historically silly. Consumers have always reacted conservatively to tough times--recoveries have never been fueled by consumer borrowing. Despite all you read, consumer debt as a percent of personal income has always been flat to down in the 18 months after a recovery's birth. That so many otherwise seemingly intelligent and educated seers seem to have so overlooked this fact is astounding. Consumer debt won't impede this recovery, just as it didn't fuel past ones.
Knowing that 1991 and 1992 were great times to buy and own stocks, you can be confident that now is a good time, too. Is it different now? Of course. But it's also much the same. The four most dangerous words in English: "It's different this time."
Bush I. Bush II. Take your pick of administrations. Bush I then had the highest popularity rating in the history of polling. Bush II now has the highest, longest average popularity of any President ever. It was and is the third year of a presidential term, when the market usually does well. So we are in a similar political cycle (although the first Bush didn't enjoy the advantage of a Republican Congress). More similar than different.
We fretted mightily over the market's high valuations then, and I wrote much about how that wouldn't stop the market. It won't now. We fretted over a weak economic recovery then, and now. Recall candidate Bill Clinton campaigning in 1992, with the slogan: "It's the economy, stupid"? The gurus then saw a below-average decade ahead, and they see the same now. Why? Because the prior decade had been too good for the next one to be anything but bad. The times ahead are going to be good. Enjoy them.
(Excerpt) Read more at forbes.com ...
When you're servicing debt that is 3 times your income, how much more can you take on? A recession is simply the realignment of production to meet (reduced) demand when people are servicing the debt they accumulated in the boom. You'll have to forgive the prognosticators of the early 90's, they never imagined Alan Greenspan would initiate and perpetuate such a credit orgy...
History doesn't jive with your observations. Why didn't the ratio of debt to GDP decline significantly after the '81 recession? From '85-'90 debt outgrew the economy, and the same thing happened again roughly 95-00. Do you think debt/earnings ratio can keep climbing without imperilling the ability to make current/future purchases? Please explain, I'm curious. If a someone is making $50,000/yr and servicing $150,000 of debt, do you think that negatively impacts his ability to make additional purchases today and tomorrow? Lower interest rates will increase the amount of debt he can service, but you do realize there is a limit, right? What happens when someone takes on more debt than they can service? They default. Many people are going to learn that what they always considered their savings were really someone else's debt, and when the defaults start rolling, well, we've played that game before...
"Do you think debt/earnings ratio can keep climbing without imperilling the ability to make current/future purchases? Please explain, I'm curious.
As long as earnings increase, yes. this is basic. do you really not understand that?
If a someone is making $50,000/yr and servicing $150,000 of debt, do you think that negatively impacts his ability to make additional purchases today and tomorrow?
obviously it depends on other factors like the rate of interest and other fixed costs incurred by the borrower. Without such the question is unanswerable.
Lower interest rates will increase the amount of debt he can service, but you do realize there is a limit, right?
there is certainly a limit but it's not the one you bears keep hyping - I personally don't mind if somebody has to pay out the same out of money to borrow more money at a lower rate. It's the same principle (pun intended) as you folks get in such a tizzy about that people have been getting lower rate mortgages that allow them to buy bigger, more expensive houses for the same bottom line as they could previously buy smaller, cheaper houses at higher rates. I like people getting more bang for less bucks!
What happens when someone takes on more debt than they can service? They default.
some do, some have, some always will. duh. this has happened since near the dawn of earth and yet the earth still turns.
Many people are going to learn that what they always considered their savings were really someone else's debt
this is beyond hyperbole and not applicable to myself.
and when the defaults start rolling, well, we've played that game before...
I'll leave it to you, I've never played that game before as I'm not that stupid. But thanks for the admission as the rest of your fearmongering all makes sense now ;)
That's why absolute measures wouldn't tell you much. It's why the notion of "record" deficits isn't as important as what proportion of GDP those deficits represent. However, the graph isn't a graph of absolute debt, but instead of the ratio of debt to GDP (the means to pay off the debt). In short, it specifically addresses your argument of debt increasing correspondingly with GDP by showing how much faster it has grown than GDP of late.
The only time that wasn't true, and the graph inadvertently shows it, is during periods of economic stagnation or decline.
The reason the debt ratio spiked after (as opposed to before or at) the market collapse of '29 was because GDP declined faster than debt initially. After a period of readjustment, and even in spite of FDR's deficit spending binge, the defaulted debt came off the books, and the ratio subsided.
Do you really wish the economy would perform like it would during the years of depression?
My fear is that the government will foster another long period of economic stagnation, yes, but I don't wish it. I see the same factors at play. A federal reserve fostering a credit bubble, trade under attack, and incessant government meddling in business. I don't foresee another FDR trying to turn our nation into a fascist state, but who foresaw him?
"Do you think debt/earnings ratio can keep climbing without imperilling the ability to make current/future purchases? Please explain, I'm curious.
As long as earnings increase, yes. this is basic. do you really not understand that?
In all politeness, I suggest reading more closely. Do you think the debt/earnings ratio can keep climbing without imperilling the ability to make current/future purchases?. We now make about $100 for every $300 of debt. As unavoidable consequence, production in the future must be allocated to pay for our consumption in the past. If we continue spending a larger and larger portion of the money we will earn tomorrow today, what will we spend tomorrow? The recession is when 'tomorrow' arrives, and the consumer can't take on anymore debt, forcing production to realign with his reduced demand while he works off the excess debt. Greenspan has managed to delay this unavoidable curative aspect of markets and as consequence made the final reckoning that much worse (by putting that much more debt into the system to be worked off and sending producers demand signals that are higher than they would otherwise be).
If a someone is making $50,000/yr and servicing $150,000 of debt, do you think that negatively impacts his ability to make additional purchases today and tomorrow?
obviously it depends on other factors like the rate of interest and other fixed costs incurred by the borrower. Without such the question is unanswerable.
Actually, it's not. It's really very simple. When you borrow, you are foregoing consumption in the future, for consumption now. Hence, debt based consumption negatively impacts the amount of money available for consumption in the future. It is already allocated to pay for yesterday's loan, it can't be used for today or tomorrows new spending.
If I borrow $50,000 to buy a Corvette I have to pay that thing off. My $1000 a month car payment for the next five years is going toward that car, made in the past. That $1000 every month for the next 5 years isn't available to GM or any other producer until the debt is serviced and erased. If I kept buying cars soon all my monthly income would be taken up making car payments, with no money left over to spend on what I want today or tomorrow.
When the debt load reaches zenith GM and other producers are forced to realign production with current demand, and if I'm stuck servicing yesterday's debts I've got no money to make demands on them with. That's when they start laying off workers and reducing production. It's not until I erase the debt and can afford to start buying again that they can increase production and start hiring again.
What happens when someone takes on more debt than they can service? They default.
some do, some have, some always will. duh. this has happened since near the dawn of earth and yet the earth still turns.
I don't expect it to stop the earth, but simply intended to point out that periods of excessive credit are followed by excessive default.
I read this again and my answer is the same - as long as earnings improve then the ratio remains the same. In the case of many corporate refinancings or mortgage refinancings there is usually a considerable improvement in current ratios because of the ability to pay off more principal. I recognize that stupid people and stupid companies will not proceed that way but that's an exception. The rule is to not do so and good companies and wise individuals are not :)
I read this again and my answer is the same - as long as earnings improve then the ratio remains the same.
Earnings haven't been keeping up, and that is precisely what the graph shows. The ratio is climbing. In 1984 debt was ~160% of earnings, by 1990 debt had climbed to 240% of earnings, now it's ~300% of earnings. You realize this growth can't go on forever, it's only by manipulating the credit markets (and blatant threat to continue pumping money into the market) that this much debt has been carried this far.
I recognize that stupid people and stupid companies will not proceed that way but that's an exception. The rule is to not do so and good companies and wise individuals are not :)
"Who makes up the majority in any country--the intelligent, or the stupid? I think we've got to agree that, all over this whole wide earth, the stupid are in a fearsomely overpowering majority."-Henrik Ibsen, An Enemy of the People ;)
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