Amid a constant barrage of news about fiscal cliffs, and government deficits, and confidence deficits, and European meltdowns, and “muddle through” economies over the past few years, it’s easy to lose sight of an issue that’s played an instrumental part in the massive economic headwinds in the first place. Ultimately, the severity of the 2008-2009 recession and the subsequent economic malaise, at least in relative terms to the economic rebounds we’ve seen during past post-war episodes, was attributable in major part to the massive reversal of a US consumer credit bubble that was decades in the making.
Look at the first chart below, which represent total household debt relative to disposable income in the US. The chart is based on data provided by the Federal Reserve Bank from 1965 through Q3, 2012. Between the mid 1960s until the early 1980s, debt as a percentage of disposable income remained relatively stationary. From the early 1980s until 2007, households piled on debt at an ever-increasing pace relative to incomes. Granted, the near parabolic move higher during the last stretches of the credit bubble was mainly attributable to mortgages outstanding, but the point remains the same. Accelerating debt dynamics provided a turbo boost to economic growth, and probably masked underlying structural issues with US economic growth, especially from 2000, or so, to 2007. The level of household debt relative to income peaked out at 129.4% in Q3:2007. Since that time, it’s fallen to approximately 108%. Further demonstrating the dynamic, below the first chart providing total household debt, we’ve also provided a chart based on data from the New York Fed which breaks debt out into individual consumer components such as auto loan debt, credit card debt, revolving home equity debt, and student loan debt. As you can see, the ex-mortgage consumer credit categories have been in steady decline for the past several years as well (except for one category: student loans).
Just as increasing use of credit provided a tailwind to US economic growth for years, the subsequent deleveraging among households has been an albatross. The aftermaths of massive credit bubbles aren’t pretty and are historically marked by years and years of substandard economic growth. The event unfolding in the US seems to be unfolding according to the template outlined in the Rogoff and Reinhart book, This Time is Different. Massive private sector credit bubbles prick, creating financial crises. As governments work to offset the negative effects of the crisis, the debt baton is passed on to sovereigns/governments. Ultimately, overburdened sovereigns dispense of obligations through various strategies, such as financial repression, monetizing/inflation, or default. Whatever the trajectory, economic growth usually remains subdued for an extended period as economies adjust, rebalance, and digest; there’s very little policy makers can do.
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| Source: Federal Reserve |
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| Source: Federal Reserve Bank of New York |
Where do we stand in the overall process? What’s amazing is the fact that the US finished 1999 and entered the 2000s with a household debt to disposable income ratio of approximately 91.5%, nearly 20 percentage points below the current level. It’s obviously impossible to make definitely predictions on a debt trajectory from here, but it’s not unfathomable to think that total household debt will continue to work lower, especially considering the general aging of US society and other dynamics. Maybe consumers will dedicate more of their disposable income to debt reduction, or perhaps institutions will write off more debt, such as mortgage balances. Either way, the headwinds will probably continue.
Atlanta Fed President Dennis Lockhart’s comments below, made during a speech in late 2011, succinctly describe the deleveraging process and the ongoing ill-economic effects associated with the aftermath of a credit bubble:
"It is necessary that the process of deleveraging plays itself out, which may take several more years. When economies are deleveraging they cannot grow as rapidly as they might otherwise. It is obvious that as consumers reduce spending they divert more of their incomes to paying off debt. This shift in consumer behavior increases the amount of capital available for financing investment. But higher rates of business investment are not likely to fully offset weakness in consumer spending for some time, as businesses continue to grapple with uncertainties about the future.
…Rebalancing simply takes time. A 2010 report by McKinsey surveyed 32 international periods of deleveraging following financial crises and found that, on average, the duration of these episodes was about six and a half years. U.S. debt to GDP peaked in the first quarter of 2009. By that standard we are much closer to the beginning than the end of our deleveraging process."
If Lockhart is correct, the frustrations we’ve experienced over the past three years with the three steps forward, two steps back recovery will probably remain in place.
