• U.S.

Over The Ears in Debt

10 minute read
George Russell

The obligations have been piling up for years in almost every cranny of the U.S. economy: Treasury bonds, corporate securities, household mortgages, consumer credit-card slips. Taken together, all the promissory pieces of paper have had a magical ability to help sustain one of the longest periods of economic growth in U.S. history. But as that expansion moves well into its 18th quarter, fears are rising about how long the magic can last. Suddenly, alarms are sounding louder than ever that those handy piles of debt are taking on the messy proportions of a potential crisis. Individuals, corporations and even Uncle Sam himself are, to put it bluntly, in hock as never before in history. To many concerned experts, the question is not whether but how much the mountainous burden of debt is threatening the economy and the future welfare of every American.

The nature and scope of the U.S. debt problem came under scrutiny last week at a meeting of TIME’s Board of Economists in Manhattan. The consensus was that American debt levels, while still manageable, are reaching dangerous proportions. Even if the rate of debt expansion is substantially slowed soon, the total amount of the obligations will continue to increase to even more formidable levels. The costs of making payments on the debt will increase dramatically into the 1990s, leading to a significant slowdown in improvements in the U.S. standard of living.

An even greater peril, in the view of TIME’s economists, is the effect of the debt burden on U.S. corporations and consumers in the event of recession. So extended are American businesses and individuals that the resulting bankruptcies and attendant hardships would probably be more severe than during any downturn in recent memory. Says Board Member Lester Thurow, an economist at M.I.T.: “You are going to have more personal defaults than normal, more corporate defaults than normal, more Third World debtor defaults than normal — all of those dominoes tumbling at the same time.”

The dominoes are not likely to fall in the immediate future, however. Looking at the economy’s current performance, TIME’s board members forecast a 2.9% growth rate in the gross national product during 1987. That compares with a 2.5% pace in 1986. The board’s projection is even more optimistic than the average suggests, since it is based on the assumption that economic activity will pick up as 1987 progresses, ending the year at a 3.8% clip. Says Walter Heller, a University of Minnesota professor: “The winds of change are blowing our way.”

Much of that expected rise in economic activity will be the result of the falling value of the U.S. dollar, which has declined 20% against the Japanese yen and 21% against the West German mark in the past year. Heller pointed out ( that the Reagan Administration’s policy of allowing the greenback’s value to fall against those currencies has finally begun to stimulate U.S. exports by making American products less expensive overseas. That may soon improve the distressing U.S. trade deficit, which reached $170 billion last year. Nonetheless, the trade statistics do not yet show a clear-cut trend. Figures released last week showed that the January deficit was $14.78 billion, which was $600 million lower than in November but a $4.1 billion increase from December.

The hoped-for turnaround cannot come too soon, since the trade deficit can be financed only by incurring more and more obligations to foreigners. Last year the U.S. became the world’s biggest debtor — it now owes about $200 billion. That total adds more strains and complexity to the ongoing international debt problem, which went through several new contortions last week. In Washington, officials from the world’s No. 2 debtor, Brazil, met with Federal Reserve Chairman Paul Volcker to explain their country’s decision two weeks ago to suspend interest payments on about $65 billion worth of its roughly $108 billion foreign obligations. And in Argentina (international debt: about $52 billion), the government imposed a wage and price freeze after threatening to suspend its interest payments unless the country received $2.1 billion in fresh loans. A day later the Reagan Administration agreed to provide roughly half of a $500 million injection of funds.

Even if the trade deficit declines, America’s cumulative foreign debt will continue to increase “on an explosive path,” said Harvard Professor Martin Feldstein. While predicting that the annual trade deficit would slim down to $90 billion within two or three years, he forecast that the debt total could reach a staggering $1 trillion as early as 1992. Keeping up with interest payments, he observed, would be increasingly painful. Says Feldstein: “We’re talking about a major slowdown in the rate of growth of our standard of living.”

The fastest way to cut back on the projected $1 trillion debt figure would be to push down the value of the U.S. dollar even further, and thus close the trade deficit more quickly than expected. But that strategy has significant costs. Japan and West Germany, in particular, have been feeling the economic pinch and complaining about it as the shrinking value of the dollar has cut into their exports. At a meeting in Paris on Feb. 21 and 22, finance ministers < from the U.S., West Germany, Japan, Britain, France and Canada took note of the concern by declaring they would “cooperate closely” to stabilize the dollar’s value.

Another cost of using the dollar’s further fall to prune the anticipated foreign debt would be increased inflation as higher import prices are passed along to American consumers. Said Rimmer de Vries, chief international economist for Morgan Guaranty Trust: “The irony is, we need some higher inflation. Otherwise, there won’t be improvement in the trade deficit.” The Commerce Department reported last week that the Consumer Price Index, paced by a large increase in gasoline prices, shot up at an 8.3% annual rate in January. That was almost surely a temporary spurt, but TIME’s economists agreed that inflation is on an upward trend. For 1987 as a whole, they predicted price increases of 4.5%, in contrast to last year’s 1.1%, the lowest since the 1960s.

One of the major forces fueling the accumulation of foreign debt, the economists noted, is the persistence of large U.S. budget deficits, which have increased consumer income and stimulated demand for imports. Between 1980 and 1986 those deficits added more than $1 trillion to the national debt, bringing the total to a horrifying $2.1 trillion — most of which, however, is still owed to Americans rather than foreigners. The chief hope for constraining the deficit has been the Gramm-Rudman law. The measure has led Congress to reduce the projected 1987 budget deficit to $173 billion, some $48 billion below last year’s level. To meet next year’s Gramm-Rudman target of $108 billion, Congress would need to cut about $65 billion more. But the Democratic chairmen of both the Senate and House budget committees last week declared that the Gramm-Rudman target would be impossible to meet. Their comments suggested that Congress may vote to amend the Gramm-Rudman goals.

A weakening of budget-cutting resolve could have dire consequences. Currently, noted Board Member Alice Rivlin, director of economic studies at Washington’s Brookings Institution and a former head of the Congressional Budget Office, “we are using more than two-thirds of our net national savings to finance the Government.” Were it not for a heavy influx of foreign capital, American businesses would have a tough time competing with the Government for scarce funds in the credit markets. If the foreign money flow slows down substantially, the budget deficit could drive up interest rates.

That could mean major trouble for American companies, which have amassed a huge debt load in comparison with the amount of stock they have outstanding. Between 1980 and 1986 the debt of nonfinancial corporations rose 35%, from $891 billion to $1.2 trillion. Many of those loans resulted from the takeover wave of recent years. While some companies borrowed heavily to make acquisitions, others went deep into debt to preserve their independence by buying up their own stock. A growing proportion of the debt is in the form of high-interest junk bonds, which may be especially risky in the event of recession.

Many companies are in danger of becoming overleveraged. Said Alan Greenspan, a New York City-based consultant: “There is a very substantial segment of corporate America that is borrowing to pay interest.” At the moment, the weight of corporate debt is being lightened by the prolonged bull market on Wall Street, which has sent the value of companies’ stocks to new heights. But the gains could easily prove ephemeral. Said Greenspan: “Any stock-market break can create some very severe financial problems.”

A special guest at last week’s TIME meeting was somewhat more optimistic. Kathleen Cooper, senior vice president and chief economist at Los Angeles’ Security Pacific National Bank, pointed out that while corporate debt in relation to companies’ income has been rising in recent years, that ratio was just as high around 1970. Many corporations, she said, are swapping short-term debt for long-term obligations to take advantage of current low interest rates and protect themselves against sudden changes in the economic climate. Said Cooper: “I don’t think it’s nearly as scary now as many people think it is.”

Of more immediate concern to most households is the level of consumer installment and mortgage debt, which has ballooned from $1.2 trillion in 1980 to $2.2 trillion now. In the past three years consumer debt grew some 40%, while personal disposable income climbed only 22%. About 15 million U.S. households now pay more than 50% of their total disposable income to service their debt, according to Greenspan. Such payments, he noted, are not a problem unless income suddenly contracts, as it might when layoffs occur during recession. In such a crisis, stricken families can lose their houses, cars and other vital possessions. Many people are making themselves more vulnerable by taking out large home-equity loans. The popularity of such loans has grown enormously under the new tax-reform law, which is phasing out the deductibility of interest payments on most other kinds of consumer credit.

Some economists have argued that the overall level of consumer debt is not alarming because the value of personal assets, including stocks and houses, has been rising just as rapidly. But Thurow pointed out that the wealth tends to be concentrated. The richest 10% of the population, for example, owns 72% of all stocks. Many of the families deepest in debt do not hold stocks or own homes.

To be sure, American individuals, corporations and Government entities need not get totally out of debt. The question is whether they can keep interest payments within manageable bounds and have enough left over to make adequate investments in the productive facilities that can provide higher standards of living. All the indications are that at every level, the U.S. economy is approaching the limits of its ability to buy now and pay later. The country’s mountainous debts, if not dangerous today, imply lowered expectations and increased economic pain in the future.

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