Show and Tell: A Comparison of Contexts for Debt

Today's graph shows total debt (public and private) in two contexts. In red, debt is shown relative to GDP. In blue, debt is shown relative to circulating money. The two are similar, but each has a feature not present in the other.

The commonly used context, GDP, is often described as the "size" of the economy. We can say the red line shows debt relative to the size of the economy. Economists say GDP measures "final spending". They would say the red line shows total debt relative to final spending.

The blue line shows debt relative to circulating money, the stock of money used for paying bills. This context is relevant because "the stock of money used for paying bills" is what we use to make the payments on our debts. Creating debt creates that money. Paying down debt destroys it.

You might think the debt number and the circulating-money number are equal. For the record, they are not.


The graph follows. The bullet points below the graph present half a century of comparison of debt in the two contexts. Touch, click, or hover on the bulleted text to display markups on the graph. Scroll the white window for additional bullets.

M1 Money (blue) and GDP (red) as Context for TCMDO Debt

Before the 1990s
  •  The red line is held down by the Great Inflation from the mid-1960s to the early 1980s.
  •  The blue line is not.
  •  The red line is driven up by the winding down of inflation in the 1980s.
  •  The blue line is not.
  •  The red line might have run parallel to the blue from 1960 to 1990, if not for the Great Inflation.

The 1990s
  •  The blue line falls for a few years after 1990, reducing the financial cost borne by each dollar of M1 money.
  •  The red line does not.
  •  The blue line shows great increase after 1993, as credit use drives growth in the "Goldilocks years" of the latter 1990s.
  •  The red line shows no comparable increase.
  •  The blue line provides better information regarding the improved economy of the Goldilocks years and the changes that prepared the economy to enjoy that improved economic performance.

The Onset of Crisis
  •  Coming out of the 1990s the blue line returns to its pre-1990 trend. The red does not.
  •  When the final rush to peak occurs, it occurs first in the blue.
  •  And in the race to the peak, the blue line gets there first.

Simon Wren-Lewis warns of "the danger of presenting increases in nominal terms, where any growth may just reflect inflation." This same danger arises when we use GDP as the context for debt.

GDP measures the output of a single year. Debt measures the accumulation of many years. The value of a dollar some years back is not the same as that of a dollar today. The value of debt and the value of GDP are affected differently by inflation. The dark red line shows a disturbance that just reflects inflation.

Mistaking the effects of inflation for real change is a valid and important concern. But we must beware also the danger of choosing a ratio that fails to show real changes. In the decade after 1985 there was an unusual drop in the growth of total debt and a substantial increase in the quantity of circulating money. These changes reduced the financial cost associated with using money, and opened a door to the improved economy of the latter 1990s. The blue line shows these changes. The red line does not.

GDP is a useful context variable. But as a context for debt, circulating money is as good or better.


For more on the anomaly of the 1990s, see Four Thoughts.

For more on the financial cost of money, see Estimating the Factor Cost of Money (2).

For more on inflation and debt, see Illusion, Reality, and the Growth of Debt and the PDF Measuring the erosion of debt.

I never thought of that!

In post from 2012, Sense and nonsense about the aging of the population, Circuit considers the aging of the baby boom. The movement of boomers out of employment and into retirement reduces the size of the workforce and increases the population that must be "carried" by those still working.

I really hate discussions like that because they pit generation against generation. Bad enough we pit black against white -- poor against poor -- in our political explanations of economic phenomena. But to set young and old against each other -- to set family members against each other -- is far more troubling.

I really like Circuit's post because it helps me resolve the problem in my mind.

The problem Circuit confronts head-on is that "over the next two decades (2011 to 2030) the number of people 65 and older will rise 78% relative to those 20 and 64." (The numbers are for Canada, but the U.S. faces a similar circumstance.)

To remedy the situation, Minister Finley is proposing to raise the eligibility age to Canada's old age security program as a way to reduce future costs and preserve the "sustainability" of federal budget costs.

Seventy-eight percent. It never seemed right to me that the baby boom generation could have that big an effect. But I didn't doubt the number. And I didn't know what to do with the problem. I never thought about it beyond that.

Circuit thought about it. He says the workforce doesn't just carry retirees. He says the workforce carries everyone who's not working. And that's always how it is.

So looking at it that way,

... when the entire population is considered relative to the working-age population, we note that the ratio rises from 159% to 180% ...

In other words, the actual "burden" of aging based on current projections consists of an additional 13% more people per working-age person. This is much smaller than the 78% that is currently being mentioned by commentators and politicians.

What a relief! And -- as a baby boomer myself -- the 13% number is much more believable than 78%.

I wish I thought of that.


Today -- 24 December -- is my last day of work. I'm retiring after the Christmas party.

Merry Christmas & Happy Holidays.

"only then can we really see if rising debt is something we should be concerned about"

Simon says

Figures for aggregate personal debt should always be normalised with respect to household income, because only then can we really see if rising debt is something we should be concerned about, or just the result of growing incomes.

Lets look at that.

The first problem is to pick some appropriate data. I'm just gonna use "disposable personal income" -- personal income after taxes -- and CMDEBT, FRED's measure of household debt. I don't have good reasons for choosing these two particular series. I'm not an economist; I don't know these things. Usually I try to use the same data that the guy I quoted was using. But Simon is making a general statement and doesn't get into specific data. I'm on my own here.

At FRED I put CMDEBT over DPI, turned off the recession bars, and took five snapshots of the graph, with the mouse highlighting five different turning points in the plotted line. I cut and pasted them to get all five turning point indicators in one picture:

Graph #1: Household Debt relative to Disposable Personal Income, 1952-2015

Approximate dates of the turning points:

1 = 1964Q4 ... 2 = 1984Q3 ... 3 = 1987Q2 ... 4 = 2001Q1 ... 5 = 2007Q4

Before turning point 1:	rapid increase
From turning point 1 to 2:	not much change at all
From turning point 2 to 3:	very rapid increase, faster than the years before #1
From turning point 3 to 4:	gradual increase (slower than the years before #1)
From turning point 4 to 5:	very rapid increase, like 2 to 3, for a longer period
After turning point 5:	decline, at first very rapid but then gradual.

So -- what does all this mean? Can you see from the graph whether "rising debt is something we should be concerned about, or just the result of growing incomes"?

I can't.

From what we know about the economy, we can look at the graph and say wow, the very rapid, sustained increase from point 4 to 5 was something we should have been concerned about.

Funny thing, though. From what I know about the economy, I look at the graph and say we should have been concerned about debt from 4 to 5... and from 3 to 4... and from 2 to 3... and from the start to 1, too. The way I look at it, debt was going up all the while.

But, you say, but debt obviously was not going up from point 1 to point 2. I think that's what you say. And then you might add: so the debt problem could not have started before turning point 2.

Many people think that. It is true that the plotted line on Graph #1 runs pretty flat from turning point 1 to 2. But that does not mean debt wasn't going up. All it means is that debt wasn't going up relative to disposable personal income. It means debt and DPI were going up about the same, from point 1 to point 2. In the other periods, 2 to 3 and 3 to 4 and 4 to 5 (and also before point 1) debt was going up faster than DPI. That's what makes the line go up, debt going up faster than DPI.

Oh, and after turning point 5, debt is going up more slowly than DPI. That's what makes the line go down. Yeah. And the line going down is how we know rising debt is something we should have been concerned about before the peak at turning point 5.

Sadly, you don't know it's going to be a peak until after the line starts going down. And then ... well, by then it's too late.


What about that flat spot between turning points 1 and 2? I say debt and income were growing at the same rate, give or take. To see if I'm right we can separate debt from income and look at them separately.

Graph #2 shows year-on-year increase in household debt:

Graph #2: Growth Rate of Household Debt (blue)

The numbers are all over the place, of course. But you can see the numbers are lower in the 1960s than the 1950s, and seem to drift downward till 1970. Then there are three large jumps, two in the 1970s and one in the 1980s.

Knowing that much, we can say that household debt growth in the 1960s was mostly between 5% and 10%, with an average about halfway between. Then in the 1970s the plot line races up and down, but seems fairly well centered on the line that indicates 10% growth, up from 7.5% or so the decade before.

The next graph, Graph #3, shows year-on-year increase in disposable personal income, in red. Again the line is all over the place. But it looks to be centered on the 5% line in the 1950s and the early 1960s. Then it runs a little higher, centered maybe a little above the 7.5% line for most of the 1960s and early 1970s. Then it runs higher yet, averaging somewhere close to the 10% line for most of the 1970s and early 1980s.

Graph #3: Growth Rate of Disposable Personal Income (red)

Despite all the variations visible on the two graphs, for about ten years beginning in the early 1960s the red and blue lines both average out at about 7.5% growth or a little higher. And for about ten years beginning in the early 1970s both lines average out around a 10% growth rate. For that 20-year period, the growth rate of household debt and the growth rate of disposable personal income run neck and neck.

That's why we see a flat spot for that 20-year period on Graph #1.


There is another line on Graph #3, a very faint gray line. That line also shows disposable personal income, like the red line, but with inflation stripped out of the numbers. You can see that before the mid-1960s the red and gray follow the same pattern and run close together. Then the two lines separate for about 20 years; during those years there was rather a lot of inflation. Then after the early 1980s the two lines come together again.

As you can see, the inflation of that 20-year period pushed disposable personal income up. This is the reason debt and income grew at comparable rates in those years. It explains why the debt-to-income ratio on Graph #1 runs flat in those years.

If not for that inflation, there would be no flat spot on Graph #1. The graph would show increase from inception to crisis. At what point in that counterfactual would you say rising debt becomes a concern?

Rising debt is always a concern, because policymakers don't yet know enough stop it before it brings the economy to ruin.

Mine of 14 December 2015

Simon Wren-Lewis's of 13 December -- "Using economic statistics in an impartial and informed way" -- is his draft submission to the BBC Trust (whatever that is) on the topic of using economic statistics in an impartial and informed way. Without going on a limb, I think I can safely say Simon is in favor of using economic statistics in an impartial and informed way.

Me, too.

I like his post. Mostly I like it because, in the opening paragraphs, when Simon needs an example he uses debt. And not only government debt, but also personal debt. That's good. That's progress. Not only government debt.

I do like the post also for Simon's position on his topic. Here, here's his opening:

I would just like to make a few specific points about the use of economic and financial data. This data should be presented in a way that informs the public, rather than in a way that is meaningless to everyone except experts, or worse still in a way that fosters some political position.

Oh.

Yeah.

Of course. But is there anyone who would say the opposite? Anyone who would say outright that it's bad to inform the public? Is there any rational (cough) person who would openly admit to using economic data to mislead people for political gain? I don't think so. That's the sort of thing people only say about other people.

I suppose it doesn't hurt once in a while to say out loud the thing that Simon Wren-Lewis is saying. But to my ear, what Simon says goes without saying. I want to talk about something else. I want to talk about debt and context. Simon says:

... I have seen a well known BBC financial journalist quote, without qualification, numbers for how much UK government debt is increasing every day, in a manner that is clearly designed to suggest that this is a very serious problem. But numbers like this are meaningless on their own...

Mistakes like this could be avoided to a large extent by applying some normalisation. To return to the debt example, numbers for debt and deficits should routinely be given as shares of GDP... An alternative normalisation that would make such figures more meaningful would be to divide them by total household income. Figures for aggregate personal debt should always be normalised with respect to household income, because only then can we really see if rising debt is something we should be concerned about, or just the result of growing incomes

Now we're talking.

Here, look at this:

numbers for debt and deficits should routinely be given as shares of GDP

and this:

An alternative normalisation that would make such figures more meaningful would be to divide them by total household income.

Simon wants to see the numbers in context. (So do I.) He explains:

Figures for aggregate personal debt should always be normalised with respect to household income, because only then can we really see if rising debt is something we should be concerned about, or just the result of growing incomes

He wants to see debt in relation to income -- government debt in relation to GDP, personal debt in relation to personal income.

But Simon says not everything should be put in the context of GDP. GDP, for example. Simon would put GDP in the context of population. "Per capita growth is much more relevant for the public," Simon says, "because it is closer to how fast average incomes are growing."

I agree with Simon when he says context is important. I agree when he says GDP (or income) is not always the best context. But for debt, oddly, Simon would "routinely" use GDP or income as the context. I would not.

"Routinely" -- That mean something like "without having to stop and think about it". That's a problem. Using GDP for context without ever stopping to think about it is just as bad as providing no context at all: just as thoughtless, and possibly just as wrong.

But you cannot know if it's just as wrong, unless you stop and think about it.


Sometimes an employer will borrow money in order to meet payroll. When the employer hands out the paychecks he is creating income. Do you think this newly created income provides a good "context" for debt? I don't. It's new debt that created the income. Use income as a context for debt and you are looking at how much of the debt was used to create new income, and how much was not. Not very useful.

If you stop the economy and look at it, all the debt is still there, but no income at all. Income is a terrible context for debt. I prefer to compare debt to the quantity of money available for paying the bills. The money doesn't disappear when you stop the economy. The income disappears, but not the money.

If you stop the economy and look at it, there is no income because the economy is stopped: There is no flow. But there is money. I still have the greenbacks in my pocket. You still have the money that you would have spent if we didn't stop the economy. That money is still there, even though there is no additional income being generated. We can add up all that money, our spending-money, and call it M1 or something.

We can take debt and look at it in comparison to the quantity of spending-money. Look at debt in comparison to the amount of money we have that we can use to make payments against debt. Use spending-money as the context for debt.

When you start the economy up again, and look at it, income is being generated again and now you might say income provides a good context for debt. But who can say? Maybe the economy will start up and run really fast, and generate a lot of income. Or maybe the economy will start up and run slowly, like our economy after the 2009 recession, and then not much income is generated. Who can say?

If the economy generates a lot of income, debt in the context of income looks smaller. If the economy fails to generates a lot of income, debt in the context of income doesn't look smaller. These are illusions arising from the use of income as a context for debt. These illusions do not arise when spending-money is used as the context for debt.

But you would have to stop and think about it.

No wonder she's smiling

An Exercise

Real Gross Domestic Product = RGDP

Real Gross Domestic Product per Capita = RGDP/Population

RGDP divided by RGDP/Population = Population


Put POP, FRED's version of population on a graph along with Real Gross Domestic Product divided by Real Gross Domestic Product per Capita. If the two come out the same, POP is a good data series to use for "per capita" calculations.

Graph #1

Yup.


Sample usage:

Graph #2: Potential RGDP per Capita

Immigration and economic vigor

At the "Five Short Blasts" Forum: November Employment Report Looks Strong – in the “New Normal” Economy:

... To hear economists tell it, the economy is doing great. Even the Federal Reserve has begun to sip the Kool-Aid, licking its chops at the prospect of jacking up interest rates next month.

... Our “new normal” high is 2%, or about six million workers, lower than it was before the recession...

Nevertheless, the Federal Reserve sees this as a good time to shoot a hole in the boat. I think it’ll be sorry.

Pretty interesting stuff. Well written. Shows graphs. Looks at the numbers (like "Per Capita Employment") his own way. Pretty interesting stuff.

The guy's name is Pete Murphy.

//

Murphy's post links to an older one: 315,000 More Workers Vanish in November (from back in 2011):

If President Obama has been smart enough to restrain the growth in the population through cuts in immigration, he’d now be talking about a real, significant drop in unemployment – one that actually feels like an improved economy – instead of one that’s been trumped up by proclaiming that millions have simply given up looking for work.

I don't think I ever looked at immigration. Pete got me interested.

The Migration Policy Institute has a graph showing the "annual number of U.S. legal permanent residents" for the 1820-2013 period. Plus, you can download the numbers. So, I did. Then I went to FRED looking for population numbers, for comparison.

Graph #1: Annual Number of Legal U.S. Residents as a Percent of
Total Population: All Ages including Armed Forces Overseas
(Damn! I forgot to clear the subtitle line.)

General uptrend since 1952, and an unusual spike around 1991. Dunno the explanation for the spike. Same trend (and same spike) appear at Migration Policy Institute.

Graph #1 starts out showing around 0.1% of population as immigrants. One person in a thousand. In the late years it shows 0.3 or 0.4% -- three or four in a thousand people. Three or four times the starting number, but still not a lot.

Dunno if immigrants still count as immigrants after they get citizenship, or if they come out of the count. That would affect the interpretation of the graph.

Dunno what Murphy has in mind when he says Obama should have put restraints on immigration. Looks to me like the immigrant population was falling all through the Obama years.

//

Pete Murphy's sidebar offers his proposed 28th Amendment to the Constitution of the United States. The text of it says

The United States shall not be a member to any international organization that does not recognize the United States’ fundamental right to manage international trade in its best interest.

Sounds good to me. The same proposed amendment says

The United States shall not maintain a trade deficit with the rest of the world. The Congress shall enact trade policy utilizing import quotas and tariffs as necessary ...

I have to reserve judgement on that.

I like the site because Murphy has developed his own theory -- a "theory of population density-induced decline in per capita consumption", as he puts it. I find it interesting (in the sense that I have to think about it before I know what I think about it).

On his “Free” Trade? page, Murphy lays out an overview of his theory:

... as population density rises beyond some optimum level, per capita consumption begins to decline. This occurs because, as people are forced to crowd together and conserve space, it becomes ever more impractical to own many products. Falling per capita consumption, in the face of rising productivity (per capita output, which always rises), inevitably yields rising unemployment and poverty.

He's trying to explain the decline in consumption, or the sluggishness of aggregate demand. He's got his eye on the target, and his explanation is far more interesting than Scott Sumner's. (The interesting thing about Sumner is not his solution -- print more money -- but that he manages to get away with saying it while calling himself conservative.)

My kneejerk is that the lethargy in consumption and/or aggregate demand is due to the cost of accumulated private debt, combined with the widespread desire to reduce rather than expand that debt. That seems a much stronger argument to me than Murphy's notion that overcrowding makes owning things impractical.

I've not yet read enough of Pete Murphy to pass judgement on his work. But he does leave me a bit confused.