Give Me Liberty or Give Me Debt!

In the event you’ve already binge-watched House of Cards Season Four, don’t be so quick to tune Netflix out. Instead, restore your faith in mankind and search for Brothers in War, a gripping National Geographic Vietnam War documentary that recounts the journey of Charlie Company. Though two-thirds of those who served in combat in Vietnam were volunteers, the draftees featured in Brothers were one of the last groups to go through basic training and sent to the front lines together, in this case to the unforgiving Mekong Delta. Some 50 years later in the making of this film, they reunite and marvel at their lasting bond. But most of all, these boys, now seniors, ask what gift of fate allowed them to return home at all, unlike so many of their comrades who made the ultimate sacrifice.

Among the unalienable rights generations of U.S. soldiers have fought to preserve is that of liberty, both ours and that of those in foreign lands. Little could many of those who served in the Vietnam era have known how terribly that very freedom for them as individuals would be impinged upon in their lifetimes. Among workers who are roughly the age of Vietnam veterans, 65 and older, those who work because they have to now exceed those working by choice by a factor of 2 to 1.

Several culprits contributing to their delayed retirements are easily identifiable, chiefly being a lack of savings and income. But these are merely symptoms and don’t get at the root cause of the disease. At its contaminated core is a fundamental change in our culture which has for many, blocked the pathway to achieving the American Dream. That change is an acceptance of debt, rather than investment, to power economic growth.

Evidence of this transformation has shoved its way onto front pages in recent months. Fresh data out of the New York Federal Reserve show that debt among older Americans more than doubled in the 12 years ending 2015. Specifically, the average 65-year old has 47 percent more mortgage debt and 29 percent more auto debt than 65-year olds did in 2003. Over that same period, their labor force participation rate increased to over 19 percent from 13 percent, while that of the entire labor force went in the opposite direction.

As an aside, in the event the allure of a demographic explanation appeals, seniors’ increased debt loads are not directly attributable to longer life expectancy, though that argument would be convenient. The fact is, it’s difficult to retire when your savings have been ravaged and you’re shouldering more debt.

The shame of it is, it didn’t have to be this way. The economy could have been growing organically for the past 30 years in the same vein some of the world’s most successful companies have, from the inside out, by way of reinvestment. Granted, economic growth that stems from the disciplined redeployment of earnings is not as easy to maintain. But by the same token, it leads to far less violence in the business cycle.

Austrian economists refer to the serial boom and bust cycles spawned by prolonged periods of artificially low interest rates as malinvestment. How has this scourge manifested itself since the late 1980s, as today’s Wall Street came of age, with the birth of the Greenspan put? Without getting into the nitty gritty of each iteration, a whole heck of a lot of financialization took place, for lack of a more accepted existing term.

Financial institutions and capital markets worldwide came to dominate the economic landscape by lending into every nook and cranny regulators would knowingly or inadvertently allow credit to seep. Think of the numerous emerging market debt crises, Long Term Capital Management, the dotcom revolution, the commodities supercycle, the housing bubble and finally today’s mammoth credit bubble in its various forms.

In the case of the U.S. economy, the most damning conviction of malinvestment is productivity growth that’s threatening to flat line; it ended last year up 0.5 percent over the last three months of 2014. For comparative purposes, the 30-year average is 1.9 percent.

My former colleagues at The Liscio Report, Philippa Dunne and Doug Henwood, have done extensive work on the origins of declining productivity. They found the most obvious cause to be a lack of investment on companies’ part noting that at 6.0 percent of gross domestic product (GDP), equipment and software spending is below the 1950-2015 average. “The series seems to have topped out for this cycle at levels comparable to earlier recession lows,” they remarked.

Is it that companies are simply low on cash? Not hardly, they’re just directing that cash to share buybacks and buying each other out. “That may make some people happy for a while, but it doesn’t have the feel of a long-term strategy about it,” Dunne and Henwood observed. Indeed.

But there’s something much more subtle at work according to two recently published papers, both of which are footnoted at the bottom of this piece. The first paper links shifts in the composition of the workforce to credit booms and the financial crises that inevitably follow based on 21 episodes in advanced economies since 1969.

Not only does the temporary misallocation of investment do damage during the boom period – think of all those construction jobs that were created during the boom-boom days of the housing mania. The protracted, as opposed to plain vanilla, recessions that follow credit crises also act as a drag on underlying productivity. Income levels take appreciably longer to bounce back limiting both the ability to rebuild savings and splurge on that extra something without incurring even more debt.

The second paper examines the effects of startups, or a lack thereof, on productivity growth. The break in startup activity, such as that which accompanied the 2009 financial crisis, has left a lasting impact on GDP and productivity growth. While startup activity has recovered from its 2009 lows, it remains at the average level that prevailed prior to the crisis, from 1976-2007.

Looking back, Census Bureau data leave little doubt as to how much damage has been exacted as debt has unseated investment as the main driver of the U.S. economy. Newly formed firms represented as much as 16 percent of the total in the late 1970s; that share had declined to eight percent by 2011.

As for the prognosis for future start-up activity, stabilization at a low level may be as good as it gets for the current cycle. In the fourth quarter, venture capital financing fell by 30 percent in dollar terms while the number of transactions declined by 13 percent over the prior three months.

The startups that are lucky enough to survive their first year are otherwise known as small businesses. In February, their reported optimism on the outlook fell to a two-year low according to the National Federation of Independent Businesses. Plans to hire and increase capital spending fell in concert with the number of those reporting they expected improvement in the economy holding stubbornly steady at the lowest level since November 2013.

“The small business sector is not headed up with any strength,” said Bill Dunkelberg who heads up the NFIB. “(it’s) just treading water waiting for a good reason to invest in the future.” That certainly doesn’t portend for a strong rebound in productivity.

One dot that has yet to be connected to complete this picture is how this decline in productivity has impacted households. As pointed out in the Financial Times last week, after adjusting for inflation, median U.S. household income in 2014 was $53,657, about where it was in 1996. Though it will be interesting to see the 2015 numbers once they’re released, the latest data through February show no signs of a pick-up.

That could have to do with the types of jobs that have been created over roughly the same period. Dunne and Henwood were kind enough to run the numbers. What they found: Since 1994, the ‘eat, drink and get sick’ sectors of the workforce, as they like to call them, have seen their share of the labor force pie grow by about a third. Since then, the long decline in manufacturing has continued, with its share nearly halved, while that of trade, transportation, warehousing and utilities has shrunk by a third.

It stands to reason that the industries most supported by flat incomes are those that require the least in the way of disposable incomes. As for the ‘get sick’ sector’s job growth, it’s simply a reflection of the aging and growing of the population. And so, Americans take what little they’ve got left after covering the roof over their head, the cost of which has relentlessly marched upwards thanks to cheap debt financing, and spend the remainder on doctors’ bills and a night out at their eatery of choice.

The irony is working Americans have never been so well educated. They could be doing so much more. But that’s what a lost generation of corporate investment gets an economy – plenty of degree holders but not enough high paying jobs to go around. If only this too hadn’t been financed by debt. The latest figures show government-owned student loans as a percentage of consumer debt now exceed 27 percent.

There is however a silver lining: while the average 30-year old is shouldered with three times as much student debt as in 2003, these borrowers carry so much less in the way of mortgage, credit card and car loan balances that their overall debt loads are lighter than they were 12 years ago.

Granted, this isn’t all by choice; access to mortgage debt has been restricted. Nevertheless, the glass is half full interpretation suggests the beginnings of a tide shift in our culture. What if Millennials prove to be the first generation to reject debt as a way of life and tell central bankers what they can do with their overreaching influence?

That would be a welcome first step and a fitting salute to past generations who have fought and sometimes paid the ultimate price to uphold the principles of our founding fathers. If only it wasn’t the case that so many of the survivors of our country’s hard fought battles today find themselves with so little financial freedom.

Life, liberty and the pursuit of happiness might not come so easy to the current generation’s more fiscally prudent pioneers. But their brand of prosperity, which harkens to a bygone era that should never have gone by, might just stand the test of time and be that much more rewarding in the end.


Bank for International Settlements Working Paper No. 534: Labour reallocation and productivity dynamics; financial causes, real consequences by Claudio Borio, Enisse Kharroubi, Christian Upper and Fabrizio Zampolli, December 2015.

The Federal Reserve Bank of Chicago: Firm Entry and Macroeconomic Dynamics: A State-level Analysis by François Gourio, Todd Messer, and Michael Siemer, January 2016.