Thursday, January 5, 2012

Private Debt 2012 (1): Looks like thursday is Private Debt day

Some things cannot be said often enough. Excessive private debt is the problem.

From Asymptosis: It’s the Private Debt, Stupid:
While everyone hyperventilates about government debt, they don’t seem to be aware of the massively greater load of private debt, and its spectacular runup compared to government debt:
This from Steve Keen’s latest.
The red line is private debt. The blue line is government debt.

It should be obvious where the problem lies.

I marked up a copy of Steve Keen's graph to show the "golden age" -- roughly, 1950 to 1970 -- and the years of the "macroeconomic miracle," 1994-2000.

Graph #2: Showing times of "golden" growth

At the start of the golden age, government debt was quite high, about as high as it is today. Private debt, the red line, was very low.

Because private debt was low, people were not burdened with debt. So people were willing to borrow: ready, willing, and able to borrow.

And because people were borrowing a lot, and spending a lot, the private economy grew a lot. That's the reason we had a golden age.

And because the economy grew a lot, the blue line fell a lot. Government debt fell (relative to GDP) because GDP grew at a healthy rate.

(Some people today suggest that we can use inflation to solve the problem of excessive debt. Well, inflation does make the burden of existing debt smaller. But if we are borrowing more during the inflation, we may not reduce the debt problem at all. Look at the decade of the 1970s on the graph. During that inflationary decade, the blue line fell almost not at all. And the red line went up a lot.)

At the start of the golden age, private debt was low. Debt was not a problem. In that era it was common for people to buy a new car -- a new car -- every three years. And still, debt was not a problem.

But we let debt accumulate. The red line went up. And eventually debt did become a problem. Financial costs killed the golden age.

Based on the experience of the golden age, policymakers knew that using credit should be good for economic growth. So policymakers did things to make more credit more available. And policymakers did things to get us using more credit. And the red line went up faster. But the economy still didn't do so well because there was already too much private debt, as a result of using all that credit.

Then in the late 1980s they took away the tax deduction for interest expenses. So the red line went up less quickly, and then turned, and actually came down a little bit. Private debt fell slightly, relative to GDP. The debt burden eased a bit.

And then around 1994, when our debt was relatively low, we felt like a burden had been lifted, and our borrowing started increasing again. The red line went up, really fast this time. And because we were borrowing a lot, and spending a lot, the private economy grew a lot. And once again, the blue line came down.

In the early 1990s the private debt burden fell a little. That's the reason we had the macroeconomic miracle of the later 1990s. But it couldn't last, because the accumulation of private debt was already excessive.

If you want the private economy to grow, you must begin with a low level of private debt. But if you let private debt accumulate, eventually it kills off growth.

We have many policies that encourage the use of credit. We have no policies that encourage the repayment of debt. We let private debt accumulate.

It's a problem.

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nanute said...

I've never seen a more illustrative argument for more government debt. That is all.

The Arthurian said...

Thank you, Nute.

jim said...

Hi Art,

We used to let private debt accumulate, but not any more.

In 2007 the US total debt increased from
$47.34 Trillion to $50.87 Trillion
In that same year Nominal GDP increased by $515 billion. That was $4.3 trillion increased debt producing half a trillion in nominal growth.
Real GDP growth was only 200 billion for 2007.

In the last 10 quarters that we have data (starting Q1 2009), total debt has grown from $53.59 trillion to $53.82 Trillion and Real GDP has increased by 680 billion.

That is 230 billion of new debt producing 680 billion in real growth in 2.5 years. Meanwhile, private debt decreased by $3 trillion.

In the years 1998 to 2008 the US averaged about $1 growth for every $7 of new debt (TCMDO). The decade started with about $5 in new debt to $1 growth and ended with about $10 of new debt producing $1 in growth.

Since Jan. 2009 there has been $2.5 growth for every $1 new debt.

The ratio of annual new debt to annual increase in real growth is now closer to levels seen in the 50's and 60's. In the 50's less than $1 in new debt produced $1 in new growth. In the debt bubble it took more than $10 in new debt to produce $1 in increased real growth.

Ratio of New Debt to New Growth 1950-1960

Ratio of New Debt to New Growth in Debt Bubble


Gene Hayward said...

Nanute/Art---please elaborate. In practical terms, How does more govt debt solve the problem of private debt. Govt pays off my mortgage? Thanks.

Gene Hayward said...

...or rather, it incentives me to pay it off??

The Arthurian said...


jim said...

The evidence suggests Government debt going up is inevitable as is a decline in private debt.

Steve Keen addresses the question Here

The Arthurian said...

Hi jim,
"We used to let private debt accumulate, but not any more."

Yes... but as soon as the economy recovers enough to grow again, again we will have debt accumulation. And we will have accumulation until again it creates a severe problem.

Insanity: doing the same thing over and over again and expecting different results. (Attributed to Einstein.)

Jim, I like the way you do math.

jim said...

Hi Art,
I don't think the private sector is going to be in a position to run up debt again for a good long while.

Look at the charts you posted today. The people who ran up the debt this time were not the same people who ran up the debt in the 1920's.

nanute said...

Gene, Hope I'm not too late in responding to your question. The first thing more government debt would do is offset the major imbalance. It could in theory, pay off your mortgage, student loan or any other private debts that are not likely to be repaid. Or, it could just let the market take the hit and further weaken the economy. I'm not advocating rewarding "bad" behavior. Is it any more of a poor choice than bailing out the financial industry? All of the efforts to date have been with the intent of stabilizing the precarious banking/financial sector with no equal amount of stabilizing of consumer/private debt side of the equation. Again, there has to be an equilibrium.

Just as important, is the fact that the government never has to pay back the principal, unlike private debtors. It is only required to pay the interest on the borrowed money. It can theoretically roll over the debt as long as it has the power to tax and print money. With interest rates at current levels borrowing costs would be so low that one could expect that the inflation rate going forward to in effect, offset the cost of current interest rates. The biggest problem right now, aside from the too much private debt concern, is that there is no velocity/multiplier effect happening. Excess reserves on deposits have increased from 50 billion pre crisis, to currently 1.5 trillion as a result of QE measures. That's an awful lot of money just sitting in the vault and has in effect created a situation where everyone wants to hold money. There are dangers associated with too much debt, private or public to be sure. At the end of the day, it was policy choices that encouraged and created the excessive consumer debt, and I would argue it is policy choices that are needed to correct the problem.