“We have no Great War. No Great Depression. Our Great War’s a spiritual war . . . our Great Depression is our lives. We’ve all been raised on television to believe that one day we’d all be millionaires, and movie gods, and rock stars. But we won’t. And we’re slowly learning that fact.” – Fight Club
Depression related to debt? Unpossible!
My Mom went through the Great Depression (she was pretty old when Ma and Pa Wilder adopted me, nearly fifty) as a child, so she told us kids ALL about it. To hear her tell about it, the Depression wasn’t all that Great from her perspective, but no one wants to talk about the Mediocre Depression. One of the ways that she was impacted by the Depression was her relationship to physical objects that might be of use someday. Tinfoil that you used to cover last night’s casserole? Hey, you might be able to use that again. Aluminum pie tins? They could be cut to make a great decorative lantern (no, they couldn’t, but Ma kept them anyway). They call this “hoarding” now. Pa even built a building to hold Ma’s stuff.
The reason for her obsession was understandable. During the Depression, many times her family had to do without basic necessities. Our family was well off by comparison, but Ma Wilder never got over the times when she had so little. We wrapped our Christmas presents one year in the comics section of the Sunday paper to economize. Food? Never thrown away. It fed us, then the leftovers went to the dog. During my life as a kid, we never spent a cent on dog food. Pa Wilder eventually got her to throw away old TV Guides® (kids – it’s a tiny part of the Internet that describes “what’s on TV” that they used to print out and send to us every week).
Perspective: Pa Wilder was the president of a bank at that time. We were NOT hurting for cash.
And I recall that Grandpa McWilder plucked a fiberboard suitcase for me out of the closet so I could pack my things to come and visit him and Grandma McWilder every weekend (LINK). The suitcase was missing its original handle. Grandpa took an old leather belt and cut it and wrapped it as a handle on the suitcase. It was (probably) better than the original suitcase handle. Whenever he needed something, his first trip was not to the store, but to his shop, where he would craft whatever he needed out of wood, leather or metal.
And Ma Wilder followed her dad’s example. Her crafts were legendary, making a passable statue of Ben Franklin out of a wine bottle, some sand, a sock, some blue felt and grey yarn and some copper wire. Our family was not in need of Ben Franklin statues, but Ma Wilder liked to keep in practice, since at that time the US was also tied up in a great period of inflation – it looked like the wheels were coming off of the great capitalist experience called the United States. Interest rates to buy a house were all in double digits. Even the Treasury notes were yielding 18%+.
What this did (looking backwards) was trim all of the non-productive investments from the economy, and I do mean all. If you could stick your money in a bank account and make 12%, you’d do it. Why risk your money in a business venture, unless that business venture was really, really good?
So what business ideas got money at that point in time? Only the best. And those great ideas had to have great teams behind them. The crappy ideas were laughed out of the bank. These high interest rates also depressed the stock market. Why buy stocks when you could buy government bonds at 15%?
This high-interest rate environment led to a recession, but what followed the recession was the greatest peacetime economic expansion in history – the stage had been set by winnowing away the crappy companies.
As time went on and as the economy expanded it also changed as small companies grew to enormous size and replaced large ones that didn’t serve a purpose in the economy anymore (MicroSoft® grew, Montgomery Ward™ exploded).
The interest rate was then lowered.
And lowered. And lowered.
The idea behind this (from the standpoint of a politician) is that cheap money encourages business. Which encourages hiring. Which is one way of using the people’s money to buy their votes.
And, it’s a great idea. Companies borrow money. That makes the banker happy. People get jobs when the companies use that money to invest in stuff, like buildings, stores, employee PEZ® dispensers, Johnny Depp’s ego, factories (once upon a time we made stuff here) and oil wells.
In a functional economy, some of these businesses flourish, and some fail. The flourishing businesses more than compensate for the lost incomes (and bad loans!) of the failures. This is healthy in an economy – bad ideas, like my Internet pizza by the slice company (no, we don’t deliver, you have to pick it up) fail. Good ideas, like Amazon.com, flourish.
But as you can see above, we got to a point where the graph went . . . flat, like Johnny Depp’s career. And flat as in zero. Also like Johnny Depp’s career.
So, if high interest rates force businesses out in a Darwinian competition that only the strong survive? What happens when interest rates are low?
Well, we live here in Smallville. Smallville is . . . small. It had some hotels built during the 1950’s and 60’s. And one obviously from the 1970’s. One might have been the late 1980’s. And one last hotel built around the late 1990’s. Most nights nobody is in any of these hotels. I’d bet it’s generally a 10% occupancy rate or so. Low. In a nearby town, you can buy one of the 1970’s vintage motels with 50+ rooms for $200,000 or so. Yes, you read that right. Annual income for the thing is about $120,000, and it probably nets out at $40,000 a year or so after costs. Sort of expensive for a $40,000 a year job.
But right now in our very lightly visited (and way off the beaten track of any busy highway) town they just built a brand new hotel. That might be 15% full on a good night.
Because money is historically cheap. Like 5,000 years of history cheap. Save it? Never! The investment only has to yield more than the interest rate of the loan to be profitable.
Cheap money is like gasoline to the bonfire that is our economy. To start the fire, a little is needed. But to really get the party going? Toss on more gasoline.
When there’s a competing economic system or discipline from organized investors, this won’t work. The confidence of the economic system would be lost, and interest rates would go up as people fled the money system.
If there’s an alternative. But today? There really isn’t a credible alternative to the dollar (the euro is too new, the yuan and yen are too closely held, and every other currency on the planet (except the Swiss and British) is generally more valuable as holiday wrapping paper than as actual money.
Without this constraint of an outside competitor, politicians did what politicians do. They opened the spout to the money supply. Yay! We can borrow and spend ourselves into infinite economic prosperity, right?
A little debt adds a lot of GDP. It funds great ideas like desktop computers to massively increase business productivity. It funds control valves and robots and data systems that automate pipelines and car factories.
The big ideas get funded first. They change the world.
Eventually you get to funding ideas like “bigger cupholder” in a Camero®. You get less return, less profit with each dollar invested.
That’s shown pretty well on the following graph – it relates debt to GDP (GDP is like the country’s salary – it’s all the money the country makes). The first bits of debt (earlier on) produce the greatest growth in productivity. The last bits of debt? It shows that they aren’t horrible, but in reality this graph reflects consumers getting out of debt as fast as they can during the Great Recession – individuals don’t take on more debt when they’re not sure they’ll even have a job at the PEZ® factory next month. Unless you’re Johnny Depp, in which case you just buy $30,000,000 in castles and some albino bears.
This is called diminishing returns – the latest debt doesn’t add as much to the economy, unless you really need a castle filled with albino bears and can sell tickets. The later investments are worth so much less than the previous investment. Eventually? You get debt without GDP growth, so you pay interest on the PEZ® that you ate last night. Forever. Your bonfire? The wood has burned all away, and the only thing that keeps the fire going is the gasoline. And it makes a much smaller and more dangerous fire.
Yes, eventually the added borrowed money swings your income downward, as you pay interest on investments that produce nothing.
This was like another time in history. Just wish I could remember what it was.
Maybe I should save my tinfoil now?