There’s an article over at Forbes that should warm the cockles of the hearts of those who’ve been chiding me for not posting about the dangers of private debt. Here’s a snippet:
Economists who have studied the impact of indebtedness have found that low levels of debt are essential to growth, but that high levels of total outstanding debt can hurt an economy. Beyond a tipping point, adding on more debt will reduce growth over the long run, even if it inflates a bubble in the short run.
“At low levels, debt is good. It is a source of economic growth and stability,†concluded Stephen Cecchetti, M.S. Mohanty and Fabrizio Zampolli, economists for the Bank of International Settlements, in a paper presented at the Federal Reserve’s Jackson Hole conference last August. “Beyond a certain point, debt becomes dangerous and excessive,†and can lead to increased volatility, financial fragility and slower growth. It can even bring down the real economy with it, as we have seen. Read the BIS paper, “The Real Effects of Debt.â€
Cecchetti and his co-authors found that growth can be impaired once nonfinancial corporate debt hits about 90% of GDP, or when household debts hit 85% of GDP, or when public debts hit about 85%.
In the U.S., household debt has now fallen to 84% of GDP from a peak of 98%. Nonfinancial corporate debt has fallen to 77% from a peak of 83%. Financial sector debt has plunged from 123% of GDP to 89%. Public debt has risen to 89% from 56%.
There’s an interesting graph that shows the ratio of total debt to GDP taking sudden jumps in the early 80s, the late 80s, the late 90s and another around 2000. I wish the article had included some conjectures about why that might have been.
I also found a major omission in the article: the rate at which debt to GDP is declining has slowed recently. At the present rate of decline it will a decade or more for it to return to the level it had in 2000 let alone the much more sustainable level it had in 1983. That would take centuries.
I wonder if debt to GDP is the right measure to be looking at. I realize it’s much harder to measure but how about debt to wealth? Debt to GDP may be what it was in 2005 but the Case-Shiller index is where it was in 2003. That’s not a perfect measure but it gives you the general idea.
Beyond a tipping point, adding on more debt will reduce growth over the long run, even if it inflates a bubble in the short run.
Doesn’t this refute Paul Krugman and the disciples of Keynesian economics?
As I’ve pointed out numerous times, and been roundly criticized (and I don’t give a damn; I’m right, they are wrong) the correct measure is debt to income. You don’t service debt from GDP. You might service debt from wealth, but then you are depleting a stock of assets. People tend to avoid that.
You service debt from income. It’s credit 101. So a meme was going around awhile back that “taxes are at an all time low” as measured by taxes to GDP. Bullshit. When GDP is financed by credit and artificicially high because of that, the statistic is simply bogus.
We gotta real problem, peoples. Taxes are at an all time high, when you look at taxes to income ratios. Borrowing is at upper levels, and all entities have a max debt capacity. This game of musical chairs is about over.
The only people who don’t want to hear that are the spenders: politicians, Democrats, liberals, you pick the nameplate. The lesson of Wisconsin is that it’s game over.
@Drew- Many of us on the left have been concerned about debt, and writing about it for many years. We were concerned when Reagan started increasing it, Bush I continued, happy about Clinton, then really worried during Bush II. It is nice to see you Johnny-come-lately’s come on board. If we had been paying down debt when the economy is stronger, a necessary and ignored part of Keynesian thought, we wouldnt be here for this discussion now. Frankly, I dont think you would be here if the GOP held the POTUS office, but that is another discussion.
Frankly, I dont much give a damn if you look at debt to GDP or debt to income. I just want a consistent metric, and I dont think nominal numbers are the way to go.
@jan- No. This is talking about private debt. Drew, who knows better, cannot even bring himself to address the issue of private debt levels. I guess they must be sustainable at any level, or he finds them irrelevant. I actually know people who arent buying stuff because they are carrying too much debt. It seems pretty relevant to me.
Steve