The Lehmann Letter (SM)
You can't simultaneously cut back and spend more. Cutting back will ease the balance-sheet crisis and spending more will speed recovery. But you can't cut back and spend more at the same time.
Much of the United States and Europe – households, banks and governments - faces a balance sheet crisis: Shaky assets, depleted liquidity, too much debt and too little net worth. The evidence is all around us: Homes underwater, credit-rating downgrades and insolvent governments.
We all know the solution: Pay your debts, tighten your belt, spend less, be frugal, curtail borrowing, blah blah blah. OK, suppose we do that. Then what?
(Click on chart to enlarge)
Let's begin with the United States. As you can see from the chart, the private sector - households and businesses - cut back sharply as recession unfolded. Borrowing plunged until the private sector began repaying its debts rather than borrowing more. That was the first time this has occurred since World War II.
Looks good - and it is - until you begin contemplating the consequences. In a report released this month, the Federal Reserve reported that private sector borrowing (households and business) had fallen from $574.4 billion in 2011's fourth-quarter to $564.6 billion in 2012's first quarter.
“D.2 Credit Market Borrowing by Sector”
Now that private-sector borrowing is only one fourth of what it was before recession hit (see chart), ask yourself: "How are households going to buy all the homes and cars required to hasten economic expansion?" They can't do it without borrowing and they can't repair their balance sheets if they do borrow. We're in a jam.
There is no easy exit from this predicament. Cutting back will ease the balance-sheet crisis and spending more will speed recovery. But you can't cut back and spend more at the same time.
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