The Debt Bubble – A Letter to Ben Bernanke

The America isn’t in a recession, but rather in a period of introspection.

The current market turbulence isn’t from just a freak event like the 1989 recession.  It’s not the irrational exuberance of the Dot-Com bubble.  It is something firmly rooted to the foundations of our economy.  Something that if we react rationally to, we can resolve smoothly, and something that if we ignore will drag the country into the toilet.

America is not correcting from a Housing Bubble.  It’s in a Debt Bubble.  

Throughout the 20th century America amassed enormous wealth.  Much of that was through solid innovation, good mobilization of industry, and a huge supply of untapped natural resources.  However, over the past 30 years or so we’ve been borrowing off much of our country’s intrinsic wealth in the form of increasing debt.

After the 2002 market crash, the Federal Reserve dropped interest rates to historic lows, causing a feeding frenzy in the housing market.  The record low interest rates allowed banks to issue subprime mortgages rates.  Credit card companies issued cards that were interest free for a year – free money for a year.  The average American’s personal credit card debt rose to around $8,000.  These low interest rates also minimized the rewards of consumers saving their money due to lower savings account interest rates for consumers.  Savings have declined significantly and families have increasingly borrowed against the equity in their homes.  The loosening of the Fed’s purse strings had the effect of deflating the U.S. dollar causing it to loose about 1/3 of its value when compared to the euro since 2000.  And partly because of foreign entanglements, the Federal Government began borrowing heavily from other nations.  The national debt has doubled over the past 8 years.  Currently about 20 percent of all federal taxes collection goes to the pay just the interest on the national debt.  Something is terribly wrong here.

Don’t blame Ben Bernanke for what is occurring because this largely a result of Greenspan’s policies.

This core of the market’s turbulence have been difficult for the average American to identify because they are being felt in so many areas of the economy.  The housing crisis was only the first indication of how dependent we’ve been on debt, and successive ripples are being felt throughout the economy.

Some have mentioned the dreaded stagflation (a period of inflation with decreasing economic activity).  High jobless rates probably won’t occur because people are so chained to debt that they’ll be forced to work for lower wage jobs rather than to not work at all.  But regardless, America’s purchasing power, both at the individual level and national level has been shrinking.  Have you noticed gas triple over the past 7 years?

So what Bernanke to do?

A temporary way to stop the initial drop from being too abrupt has been through a slight easing of Federal Reserve interest rates.  The stock market has pulled back in realization that the equities were priced based upon a frenzied consumer spending level.  One must acknowledge that previous consumer spending levels were unsustainable if they were leveraged so heavily upon debt.

To inflate the stock market, traders may call to have rates lowered too far and for too long.  Doing so will only increase the debt bubble and further drains the intrinsic wealth of the nation.  This is a situation that the Federal Reserve cannot solve by itself as it has a only a limited set of tools.  Bernanke can’t resolve this by himself.  This is bigger than the fed.  Part of the solution is going to depend upon the actions of the government, and I’m not talking about a check in the mail.

Decreasing Debt – Increasing Competitiveness

For all our dislikes of government, it serves some vital roles, and we’re stuck with it.  It shapes the regulatory environment that capitalism functions.  Rather than try to castrate it, like some radio talk show jocks recommended, it must be tuned like a machine.

There needs to be a fundamental shift in the country’s economic policy because the current system is not sustainable.  Just as a responsible corporation manages its debt, the U.S. must do the same by balancing the budget.  And as a nation we must examine how we are going to increase competitiveness and reverse our trade deficit.  We need to begin a conversation in what Bill Gates calls ‘Creative Capitalism’.  This doesn’t mean abandoning the parts of the system that work, but rather adjusting policies so that America is building its wealth rather than usurping it.

The solution is not a partisan one.  Cutting government spending slows the economy just like cutting consumer spending does, so any reduction in government spending must be done with care.  But we must fund government programs without depending so heavily on foreign debt.  Any politician calling for tax cuts without adequately funding their spending is simply irresponsible.  But at the same time the government must do what it can to give the country an edge: A fresh look at education; programs that promote sustainable growth of natural resources and industry; encouraging a more equitable distribution of wealth.  Leveraging upon some foreign debt is ok if we’re growing and investing wisely.  But to do so we must seriously look to where we want to be as a nation in 50 years.