Credit Update: Government Debt Spikes

Posted October 4, 2018

Our economic system evolved from Capitalism into Creditism once money ceased to be backed by gold 50 years ago.  Under Capitalism, economic growth was driven by Saving and Investment.  Under Creditism, economic growth is driven by Credit Creation and Consumption.  Between 1952 and 2009, every time Credit (adjusted for inflation) grew by less than 2%, the economy went into recession.  In other words, if Credit does not expand, neither will the economy. That is why it is important to monitor and forecast credit growth.

The new Macro Watch video dissects the Fed’s latest “Financial Accounts Of The United States” and discusses trends in debt growth for every major sector of the economy. Most striking was a large jump in government debt.  During the year to mid-2018, total debt increased by $3.2 trillion, with an $1.3 trillion increase in government debt accounting for 40% of the total increase. 

This strong dose of Keynesian fiscal stimulus has kept Total Debt (adjusted for inflation) growing at a rate just above the recession threshold of 2%.  That, combined with rapid asset price inflation, is generating above potential economic growth.

The asset price boom, however, is dependent on low interest rates; and interest rates are rising.  The Fed has increased the Federal Funds rate from 0% to 2.0%, and plans to increase it further to roughly 3.25% over the next 18 months or so.  The sharp increase in government borrowing should also push interest rates higher, as the budget deficit is expected to top $1 trillion in 2019.  This is particularly true since the government will have to borrow much more just as the Fed is destroying money on an unprecedented scale. The Fed is now destroying $50 billion per month through Quantitative Tightening.    Finally, tariffs on imports from China are likely to push up prices in the United States.  If they do, rising inflation would drive interest rates higher, too

If interest rates do continue to increase, Credit growth is likely to fall below the 2% recession threshold and asset prices are likely to correct sharply.  The combination of weak credit growth and falling asset prices would almost certainly throw the United States into a server recession.  If interest rates continue to move higher, 2019 is likely to be a rough year for the economy and for investors.

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