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Less Savings, More Debt, Increasing Vulnerabilities

Total debt in the United States increased by $2.6 trillion last year. This year it will increase by roughly $2.9 trillion. For every debtor, there is a lender. The new Macro Watch video shows who acquired the new debt that was sold in 2017 and who is likely to acquire the new debt that will be sold in 2018. It also considers the three sources of the money that are now financing US borrowing:

Savings
Money Creation by Central Banks
Credit Creation by Banks and other Financial Institutions

As recently as the 1960s, US Savings funded all US borrowing. Those days are far behind us. Last year, Savings funded only 21% of all US debt. Personal savings as a percent of disposable personal income fell to 2.6% at the end of 2017. Other than during mid-2005, it has never been lower. Net National Savings as a percent of gross national income was also near a record all time low, at 1.3%. In 2018, Net National Savings is likely to fall further as the government borrows heavily to finance its expanding budget deficits.

The “Rest Of The World”, primarily foreign central banks, own 17% of all US debt. The Fed owns 6%. With the US trade deficit widening, foreign central banks can be counted on to print more money and buy even more US debt this year. The Fed, however, will, in effect, be a seller rather than a buyer of debt for the next three years as it allows its bond portfolio to mature and wind down. Consequently, Quantitative Tightening will largely offset the debt purchases made by the Rest Of The World.

That means if Credit is going to expand enough to keep the US out of recession this year then it is going to have to be financed through Credit Creation by the banks and other financial institutions. There is no limit as to how much Credit the banking system can create through fractional reserve banking – other than the ability of the borrowers to pay interest on the money they have been lent.

And there, of course, is the problem. The private sector remains heavily indebted and the growth in real disposable personal income remains depressed. Income is not expanding as rapidly as debt. All of this points to the increasing vulnerability of the financial sector.

Now that Borrowing is funded primarily by Credit Creation, the economy is much more sensitive to interest rates than it was in the past. If the Fed continues tightening monetary policy through interest rate hikes and Quantitative Tightening, it is very likely to set off a new wave of loan defaults. Should that occur, Credit would contract and the economy would quickly slide back into a severe recession.