In thinking about the possible extent of the current economic crisis, I have been focused on understanding the role of debt. I first started looking at household debt. The Federal Reserve publishes statistics called the “Flow of Funds” which track sources and uses of capital in the economy over time. The following chart shows household debt, broken down into consumer debt (credit cards) and home mortgages, starting in 1966.
The chart shows an eye-popping explosion in debt from a few hundred billion dollars to over 13 trillion dollars. Of course there are a number of things one needs to correct for. First up, inflation. Dollars in 1996 were worth a lot more than dollars now. Using 1990 as a base year and applying the CPI as published by the Bureau of Labor Statistics results in the following chart.
So that takes some of the slope out of the chart. Next one might argue that there are more households in the US now than there were in 1966 and that one really needs to look at this on a per household basis. Thankfully the Census Bureau provides a time series of the number of households. Using this series results in the following per household chart.
While this results in a further reduction in the slope of the debt curve, the overall numbers are still impressive. In constant 1990 dollars (meaning the effect of inflation has been taken out), the per household debt in 1966 was less than $25,000 and by 2007 had grown to over $70,000. Finally, one might argue that households can afford more debt because they have more income so that one should really look at is the household debt level relative to household income. Using the Census Bureau’s household income data gives the following picture.
Household debt went from 74% of income in 1966 to an amazing 165% in 2007. Since these numbers are averages and since there are clearly some housholds that have very little or no debt, it means that there are many households that have more debt than 2 years worth of income. Even if one of those households were able to save 10% of income, it would take them 20 years to pay off their debt. And a 10% savings rate is high in the US. In fact, the aggregate savings rate was as low as 5% by 2004 and by 2007 had gone negative.
As the charts show quite clearly, the first significant acceleration of household debt started around 1984. It is likely that this was in response to a drop in interest rates after Volcker had used high interest rates to fight inflation. But the really steep increase starts in 2002 and directly reflects the real estate bubble.
One might ask, so what? Well it turns out that consumers were responsible for a large part of economic growth in the US. During the period from 2002 to 2007, consumers accounted for almost 75% of all economic growth and for the longer period of 1985 to 2007, consumers accounted for over 77% of growth (this is based on the National Accounts data published by the Bureau of Economic Analysis). So arguably, we have had at least 5 years and possibly over 20 years of economic growth that was significatly in excess of a long term sustainable rate, with the excess fueled by increasing household debt. Now, with the implosion of the housing bubble and the threat of a global recession with massive layoffs, consumer spending is drying up rapidly. There is actually an interesting bit of detail in the BEA data which breaks out whether consumer spending was on non-durable goods, durable goods or services. In 1966 consumer spending on durable goods accounted for only 26% of GDP, but by 2007 that had risen to 42% – think new cars, personal computers, etc. Of course those durables are exactly the area where it is easiest for consumers to delay new purchases, which means that the drop off in consumption is likely to be rather abrupt.
