The United States is a market economy that operates on a credit-based system. This credit-based system is a system in which the creation of money is based on credit. The monetary value in such a system is the result of some future obligation or claim. As such, credit money emerges from an extension of credit or issuance of debt. Since our economy operates under a credit-based system, the way to stimulate economic activity in such a system is by reducing interest rates to encourage borrowing. The more people borrow, the more debt is issued. The Federal Reserve is the institution that injects a large quantity of money into the economy through financial markets. This credit money is then given to commercial banks, which in turn, lend that money through fractional-reserve banking by issuing loans in greater amounts than the reserves they hold in their vault to entrepreneurs, investors, and households for all sorts of economic activities that encourage spending.
The Recession of 2008 was a financial crisis generated by the credit market. In a nutshell, the financial crisis of 2008 was triggered by the fact that banks loosened lending standards in the real estate market. On the one hand, commercial banks and mortgage companies were lending money to individuals who had poor credit scores at very low-interest rates. This then created a market for subprime mortgages. On the other hand, investment banks created collateralized debt obligations (CDOs) also known as mortgage-backed securities in the context of real estate, which was a pool of mortgages sold to institutional investors. The increasing number of defaults began to make these mortgage-backed securities, a risky investment since subprime mortgages were mixed with prime mortgages in these pools of mortgage-backed securities. As many investors realized, these CDOs were worthless, they attempted to unload the obligations. The ongoing chain of housing defaults from subprime lenders created a liquidity contagion that reached the upper tiers of the banking system. As a result, the bubble burst, and the crisis occurred.
Source: Axios Visuals
In 2023, we have been witnessing a new bubble in the credit market. This time, the bubble in the credit market is not associated with the real estate market neither with the banking sector but with the bond market, which is made up of public bonds and private bonds. Public bonds are simply government bonds issued to investors and private bonds are bonds issued by corporations to investors. Indeed, the federal government and too many companies have overleveraged balance sheets. It is important to understand that the total debt in the U.S. economy is more than 350% of GDP. Such a high level of debt makes the economy unsustainable and a debt crisis inevitable. The total debt in the federal government and business sector has been surging in recent years charging towards 180% of GDP. When any sector has a debt load that is more than 80% to 90%, major problems commence to emerge.
Government & Business Debt to GDP
Source: Financial Accounts of the United States
Governments have diminishing fiscal options to deploy after piling on debt during the pandemic and individual borrowers face a prolonged period of elevated interest rates. Profit pressures on corporate borrowers, meanwhile, are intensifying at an especially rapid pace as business costs remain elevated. High borrowing costs and an uncertain economic outlook means that companies are trading in the prospect of rapid growth for smaller debt loads. Businesses do not have cash to pay down debt loads. Federal government debt has surged over 100% of GDP. Because the government sector has been willing to take on debt to prevent recessions that hurt business profits, the overall U.S. business sector has been able to hold profit margins in the 11%-12% range. If household and banking sector debt fell from 193% in 2008 to 168% in 2019, but total debt-to-GDP rose from 317% in 2008 to 345% in 2019, business and government sector debt must have increased to make up that difference. In looking at the data, that is precisely what has happened. Government and business debt rose from 132% in 2008 to 177% in 2019. It has not declined as much as consumer and banking sector debts have and maintains an upward trend.
The U.S. economy did not solve the problems of 2008 and deleverage the entire system. Rather, what happened was that the banking sector and household sector deleveraged at the cost of leveraging the government sector and the business sector.