2½ Times Longer and 2½ Times Deeper

On Thursday I said

The blatantly obvious problem with excessive credit use is the cost of it.

Jim responded:

This graph suggests the cost of debt is not a problem much less THE only problem.

The burden of debt on households is currently the lowest it has been in 40 years (or more).

I responded:

Jim, the other day you said:
"What I see in [the other day's graph] is that whenever the ratio of private debt to all debt is going up it corresponds to a period of what is generally regarded as good economic times. And when the ratio is going down those are periods generally regarded as bad economic times."

I bring this up because I think one can see the same correspondences in your graph: increase (and good times) in the mid-1980s and in the mid-1990s; decline (and bad times) in the early 1990s and since the crisis.

Note that the decline since the crisis is about twice as deep as the early 1990s decline, and lasts about twice as long. Also, we appear to be at the same point on the curve now as in late 1993 -- almost ready to have an uptrend and good economic times for a while.

Your observation that "The burden of debt on households is currently the lowest it has been in 40 years (or more)" seems to be a reference in particular to the sharp decline during the past 8 years, the decline that followed from the crisis. That decline corresponds to bad economic times, as you so correctly point out.

And now that the decline seems to be bottoming out, I am willing to say we might be ready to begin a period of good times of approximately the same duration as the decline. But you seem to say that if I was right about the cost of debt being a factor related to economic performance, then the economy would be in the midst of good times right now because the cost of debt is already low.

Not at all. For the cost of debt has only just become low. So now, conditions will be able to improve.

The increase in debt (or, really, the use of credit (which is recorded as an increase in debt)) adds to good economic times. But existing debt is a cost that subtracts from good economic times. When existing debt is low it does little to hurt the good economy, and when existing debt is high it does much to hurt the good economy.

Therefore, an uptrend in credit use that begins when existing debt is at a low level is likely to be vigorous, and may continue (though with decreasing vigor as the level of existing debt rises) until the damage done by existing debt equals or exceeds the benefit derived from new credit use.

I'm not good enough with photoshop to superimpose the graphs

- John H. Cochrane

Okay... I'm looking at this part of what I said:

Note that the decline since the crisis is about twice as deep as the early 1990s decline, and lasts about twice as long. Also, we appear to be at the same point on the curve now as in late 1993 -- almost ready to have an uptrend and good economic times for a while.

Suppose we take Jim's graph and stretch it out a few years into the future. FRED lets me do that, but when I capture and display the link, it reverts back to 2015. Anyway...

Here's a screen shot:

Image #1

Next I change the blue line to dashed red, turn off the recession bars, stretch the graph out to the year 2030 again, and take another screen shot of it.

Then I load it into Paint.NET, use the "magic wand" (at 20% tolerance) to erase the white background, and save the file as a GIF:

Image #2

Then I crop it so it shows just the 1990s, and put a black border on it. Actual size:

Image #3

Then I open up Image #1 so I have two files to work with in Paint.NET. I create a new layer for Image #1.

I switch back to the cropped GIF file, make it twice as big, no, 2½ times as big, and copy it.

Then I switch back to Image #1, paste the cropped GIF into place, save and "flatten" the file, and show you what I got:

Image #4

See how the blue line, after the 2007 peak, follows very much the same path as the first few years of the dotted red overlay? This doesn't guarantee that anything will happen tomorrow, of course, but the striking similarity of the two downtrends makes me think that the uptrends might also turn out similar.

So we could soon get a few years when the economy seems pretty good again while debt races upward even faster than it did before the crisis, if we have the stomach for it. When those good years come, you know whatever political party is in power will claim all the credit.

Right now, though, nobody expects a few good years.

I don't either.