Saturday, June 16, 2012

The Hollow Men

In mine of the 12th, I quoted from a PDF by three guys from the Bank of International Settlements:

Debt is a two-edged sword. Used wisely and in moderation, it clearly improves welfare. But, when it is used imprudently and in excess, the result can be disaster. For individual households and firms, overborrowing leads to bankruptcy and financial ruin. For a country, too much debt impairs the government’s ability to deliver essential services to its citizens.

Doesn't this imply that the "overborrowing" is a recent phenomenon? It is not.

For me, the cost of excessive credit use was already a problem by the latter 1960s. In the 1970s, it was creating cost-push pressures. Those cost pressures created our "productivity slump", caused our loss of competitive advantage, and led to the major changes in policy that we still think of as Reaganomics.

The problem goes a long way back.

Data bear out these concerns – and suggest a need to look comprehensively at all forms of non-financial debt: household and corporate, as well as government. Over the past 30 years, summing these three sectors together, the ratio of debt to GDP in advanced economies has risen relentlessly from 167% in 1980 to 314% today, or by an average of more than 5 percentage points of GDP per year over the last three decades.

Yes, and over the past 30 years debt has grown much more rapidly than before. Perhaps you think this is the cause of the problem.

Let me remind you that Reaganomics was a solution. Apparently, Reagan's people thought that accumulating debt even faster would solve our economic problems. What this tells me is that we didn't really think of accumulating debt as a problem.

And what that tells me is: When the problem arose in the 1960s and became pressing in the 1970s, we did not think accumulating debt was the cause of the problem.

From the Abstract of that BIS paper:

When does debt go from good to bad? ... For government debt, the threshold is around 85% of GDP... When corporate debt goes beyond 90% of GDP, it becomes a drag on growth. And for household debt, we report a threshold around 85% of GDP...

Now, doesn't this imply that the "overborrowing" is a recent phenomenon?

Taking the US Federal debt as the "Gross Federal Debt" (FYGFD), the Federal debt reached 85% of GDP in 2009. (But one year earlier, this debt was only 70% of GDP. Did the BIS think it a problem, then?)

Household debt. FRED has a time series on that -- HDTGPDUSQ163N -- but it only goes back to 2009. So I used the household sector debt from the TCMDO series, and looked at that relative to GDP. Not a perfect match, but fair.

Anyway, household debt went above 85% of GDP in 2004 apparently. Maybe a couple years earlier if we imagine the blue line running parallel to the red one, on this FRED graph.

Finally, setting Financial debt aside (as BIS does) I looked at "Nonfinancial Corporate Business" debt as a percent of GDP. This peaks below 55% and (according to the PDF) must be no part of the problem.

For the hell of it then, I looked at "Total Credit Market Debt Owed by Domestic Financial Sectors" as a percent of GDP. This one reaches 85% already by the 2001 recession, and peaks at 120% during the crisis. I should point out, however, that the BIS PDF does not identify a problem level for Financial debt.

The earliest of these trouble points appears before 2004, but not much before. Still, if debt is accumulating, if it is heading for a benchmark, shouldn't we be able to say there are prior benchmarks at lower levels that ought to have been taken as some sort of warning? That might not take the BIS guys all the way back to the 1960s, but it would point them in the right direction.

But I don't think they're going that way. The question they ask is "When does debt go from good to bad?" They want to know how long they can wait before calling debt a problem. They want to know how close they can get to the edge. Because when a bank steps back from the edge, it makes less money.

This is not how the problem gets solved. This is the way the world ends.

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