How Private Sector Debt Hurts the Economy

As should not be surprising too much private sector debt is not good for the economy and this post at The Economist explains why that might be:

ONE of the biggest political issues in recent years has been that Wall Street has done better than Main Street. That is not just a populist slogan. A new study from the Bank for International Settlements (the central bankers’ central bank, as it is dubbed) shows exactly why rapid finance sector growth is bad for the rest of the economy.

How much is too much? When private debt goes past 100% of GDP according to the article. How much private sector debt is there now? Almost 200% according to the World Bank.

The reason they give for that effect is that as private debt grows it attracts resources including talent and investment away from sectors that would produce more future growth, not just in GDP but in decent jobs. I’d expand that conclusion to include government subsidies that favor specific sectors, e.g. healthcare and education, but maybe the people and investment that are going into healthcare these days (and over the period of the last 30 years) are just my imagination.

6 comments… add one
  • CStanley Link

    Maybe my thinking is too simplistic, but isn’t it equally important that high levels of debt crowd out nonessential spending and reduce aggregate demand?

  • TastyBits Link

    Sounds like crazy talk to me. Next they will be writing a paper about the banking cabal running the world, or so I have been told.

    The paper discusses growth, but the headline implies size. It does not go into collateral, but it does not get into using credit instruments as collateral. This is where bubbles take hold.

    Fractional reserve lending and fiat money are dangerous. They allow large pools of money/credit to be created, and this money/credit will search for a borrower.

    This money/credit will also need the infrastructure to support it. The financial industry, housing industry, education industry, etc. will all increase to support the borrower’s ability to use the funds available to him/her.

    When this is combined with purging blue collar workers and eliminating manufacturing plants, it just increases the problem. Everybody is pulling in the same direction, and the academic snobs are helping Wall Street whether they know it or not.

  • Guarneri Link

    There is so much wrong here it’s hard to know where to start.

    First we need to make note that the two biggest components of the 200% of GDP stat are consumer or household debt, and corporate debt, each at about 80%. Since the Economist article focuses on corporations let’s go there first.

    The thing that makes this guy look like a monkey is that corporate growth requires capital, and finance provides capital. To equate the financial sector with retardation of growth is therefore absurd on its face. The reference to hedge fund managers – comprised of hedge funds and private equity – is also silly in that they provide the very thing most needed for growth: risk capital. Equity. You want slow growth city? Be limited to working capital loans.

    As for starving R&D. Rubbish. Small companies do not have the credit standing to get unsecured loans to finance R&D. They need equity or high risk debt. And large firms, like aircraft that they cite? Those corporations have unsecured credit lines. Inability to finance R&D has nothing to do with the size of the financial sector, or a preference to finance steel mills or building contractors. My god. How about this switching of the chicken and egg: if a corporation has few growth options it can restructure its balance sheet with a private debt increasing stock repurchase program.

    I believe it’s been in the papers.

    Shall we switch to a more fruitful arena of inquiry? Try consumer debt. Consumer debt took off like a rocket in the mid-90s. It financed consumption, the, ahem, Clinton economic miracle. This binge carried through to the mid-aughts, the latter stage in no small part by mortgages. But like all financing, it’s an inter- temporal phenomenon. However, you finance a corporate capital asset today looking for a long term gain. But you finance consumption today………..but have to pay the piper tomorrow. You have simply moved your consumption up in time, and set the stage for less consumption later. It gets worse. The past few years has not seen wage growth or significant deleveraging. Consumption has been artificially pumped up. A perfect example is autos. Those sales numbers some crow about are coming complete (up to 38% of financing a now, I believe) with high priced subprime debt to service. That’s your growth and finance sector story.

    I’m highly dubious that hedge fund managers and bankers have drained the talent pool of engineers, physicists and mathematicians. The private equity industry is tiny in its employment numbers. I’m a rarity.

    If I didn’t know any better, and was a cynic, I might speculate that this whole “study” was designed to absolve government of its parasitic resource gobbling responsibility which causes consumers to borrow to maintain lifestyle, and corporations to crawl into their shells.

    If I was a cynic.

  • jan Link

    You’re a cynic alright Drew, but one who seems to have a good backup analysis to assist your cynicism.

  • steve Link

    The PE industry may be tiny, but the FIRE sector is not. Anyway, as Dave has pointed out, it is really the $35k starting salary for new teachers that is stealing the best grads from MIT, CalTech and Harvard.

    Steve

  • Guarneri Link

    Have I told you how private debt, and not government intrusion, is ruining the economy?

    http://www.zerohedge.com/news/2015-02-21/tesla-bonfire-money-printers-vanities

    If all those bankers were engineers, just working on perfecting Teslas………….

    I guess the technical types are too busy productively grinding out data to prove global warming is hiding in the deep sea………….with the Loch Ness Monster.

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