I think it’s really important to spell out why I think debt is at the center of the economic issues, which we are facing.
High unemployment, the tepid recovery, and market volatility can be attributed, in large part, to the deterioration of household balance sheets. Graphs do a great job illustrating this.
Here is household liabilities divided by GDP:
And household liabilities divided by income:
Lastly, household net worth:
These graphs only represent 1990 to the present; however, a look back a few decades indicates that all rose steadily until 1980, where the charts all spiked, then spiked again in 1990; however, none of those spikes came even close to the boom beginning in the early 2000’s.
Here are some takeaways, which have lead to the problems we are facing:
- Household leverage spiked without a corresponding jump in GDP. Thus, the spike in leverage was unsustainable as there was not a corresponding jump in production.
- Further, as leverage rose without a corresponding rise in GDP one could reasonably assume that resources were being misallocated, thus pushing values higher to unsustainable levels (e.g. housing).
- At the same time, incomes were not rising in line with increase in liabilities. As such, households were taking on more debt without the cash inflows to substantiate such a rise.
- How were they getting loans? Looking at the rise in net worth, it is reasonable to assume households were ramping up their borrowing due to an increase in their personal assets (e.g. housing).
A parallel situation was present in financial institutions; however, for simplicity I only covered the consumer. In my next post, I will provide more detail on what went wrong, and how we got there.
