Posted today at
Economists for Dean
A recent analysis on the economy I read somewhere made the point that some macro indicators are more characteristic of an economy in the late stages of an expansion rather than one entering a recovery. One area of concern expressed by some commentators is consumer debt. Angry Bear presents this chart .
Kash at Angry Bear discusses:
The point is simple: borrowing should typically fall during recessions, and rise during booms. The shaded areas in the graph represent recessions (approximately), and the two lines represent two important types of borrowing: borrowing by the US as a whole from foreign countries (that's the current account deficit, the blue line), and the total debt service that consumers in the US have to pay as a percent of their disposable income. As you can see, in every recession in the past, the US as whole, and consumers in particular reduce their borrowing and debt burdens. And then during every economic expansion, both measures of borrowing rise. That's how the business cycle normally works. But this time, that hasn't happened.
If the US economy were to enter a period of strong growth now, we would expect both series to rise sharply, as they have during every previous recovery. But it seems impossible that consumer debt could boom at this point, and that the US current account deficit could grow much larger. Hence my feeling that somehow, these two measures have to fall first before they can rise again - and hence my fears that the other shoe has yet to drop on the US economy.
Similarly the Economist.com via Brad Delong says:
...investors sense a chill beneath the warm glow of the numbers. One cold wind blowing across this particular recovery is that Americans are up to their necks in debt. With short-term interest rates at a 45-year low, households are spending some 13% of their disposable income on servicing their debtsâ"a higher number even than in the sharp recession of the early 1980s, when the Federal funds rate topped 13%. How much longer can they carry on spending at this rate, let alone increase it? If they don't, then someone else will have to spend on their behalf.
The government, perhaps? The Bush administration has turned a budget surplus of 2.4% of GDP into a deficit that official numbers say will amount to 4.3% of GDP next year. Not much room, in other words, to raise spending. Nor do American companies have oodles of money to play with. For all the talk of restructuring, they continue to increase their borrowing, though at least a slowdown in the rate at which they borrow and better profitability mean that their dreadful financial ratios are starting to look better than they were. Whether they will continue to do so is another matter.
My own view of the danger point of consumer debt is a little more agnostic...I recall seeing former Bush advisor Larry Lindsey in 1994 or 1995 predict that consumer debt would present a major drag on the economy. The late 90s of course turned out a booming economy as we all now know. (Lindsey was a notable bear then, but to his credit he was on the mark in his estimates of the costs of the Iraq war which probably got him fired). There have been substantial changes in credit markets that may facillitate a larger consumer debt ratio than we might have thought to be healthy in the past...but I don't know claim to know the answer.
The key however is the cost of servicing the debt. If long-term interest rates explode once the bond market uncoils, consumer debt levels may then present a serious problem. This might be especially true if those tantalizingly low introductory rates e.g. adjustable rate mortgages suddenly surge.
Lerxst