The Progress of Debt
After I posted this graph, many asked me for the data source:
http://static.10gen.com/clusterstock.com/~~/f?id=4908b4ee796c7a2000ff5a89&ctxt=wwwr1.7.1&maxX=620&maxY=471
So, I tried to replicate it, and got close — my data only begins in 1952, but the shape of the graph from there is similar, though the levels are a little lower.
/www/alephblog.com/wp-content/uploads/2008/12/
The debt figures came from the Federal Reserve’s Z.1 report, adding the Domestic nonfinancial sectors and Domestic financial sectors data from the D.3 table. I think I would reproduce the first graph if I added in the foreign debt, but that is money borrowed by foreign institutions from US institutions. But, that’s not what I am trying to analyze. I don’t care about the debts of other countries (for this purpose), only that of the US.
This graph tells two stories:
1) Increasing financial intermediation over the last 56 years, with a small over-reported disintermediation in the mid-70s. (For this purpose, money market funds are intermediaries.)
2) Relatively stable debt levels until the middle of the Reagan Administration, and then a rapid increase over the next 23 years. The increase was faster for the second term of Reagan, and for Bush, Jr, and slower for Bush, Sr, and Clinton. That said, the increase in financial intermediation accelerated during the terms of Bush, Sr, and Clinton. Securitization was running ahead, and no one was questioning it.
Upshot
From 1984 through 2008, the financial system of the US experienced a quantum leap in terms of size and complexity, which was enabled by regulatory policy and monetary policy. Monetary policy did not take away the punchbowl, and regulatory policy did not check to see if banks were lending prudently or not. Both were corrosive in the long term to a fiat currency system in the US. Both were promoted by politicians, because they accelerated “prosperity” in the US. Pity that the prosperity was fake in aggregate.
My friend Caroline Baum argues that central banks should fight debt and asset bubbles. I agree. Perhaps if central banks should have a dual mandate, it should be to maintain a certain inflation level (fairly calculated), and a certain debt/GDP ratio, say 150% at maximum. Ignore labor unemployment, and let people maximize their efforts within a paradigm that would not be given to big booms and busts.
I think this would be a good system, but I am open to comments.
December 12th, 20087:57 am at
David
In past notes you have said that too much debt caused the Great Depression and yet if you look at the chart, the big explosion in debt didn’t get started until what looks like 1931 and didn’t peak until what looks like 1935 — when the recession was well in hand. Obviously charts can be misleading to the eyes — do you have the underlying data?
I was curious how this plays into your theory about debt and depressions?
Clearly there was an Austrian boom during the 1920’s that led to malinvestment as well as leveraged structures such as utility holding companies that meant debt was overused but I was surprised to see debt within your ok range at the start of the problem.
You have mentioned that those wanting to play the high yields on corporate debt could choose closed end bond funds that own senior bank debt. I was wondering though what your thoughts are on the leverage those funds use — are the risks that you lose money faster on the downside and your distribution might get cut (e.g. Pimco) or is there something else to be worried about? Do you know of any that don’t use leverage?
as always you write great stuff — thanks
Kyle
December 12th, 20089:01 am at
Hi David.
I’m a huge fan of your blog, and I appreciate your financial wisdom. But, I think your worries about debt/GDP ratios are overblown in the short term. As long as foreign creditors are willing to keep the US Dollar and more importantly US Treasuries as the worlds reserve currency and bonds, I really don’t believe that our debt to GDP ratio will have much impact on our ability to get out of the current recession/depression that we are in.
To further illustrate the disconnect between the Great Depression and our current mess: The US did not have a Fiat currency during the Great depression. We were not the worlds reserve currency (gold was). And, there were no foreign creditors that were willing to be our debt co-dependents. Which is why I don’t believe you can draw a direct correlation between debt and recovery in the Great Depression and debt and recovery in the current mess.
That having been said… As soon as our status as the reserve currency changes (ie.. 7 stages of grieving for the US Dollar, still my favorite blog post ever), we are headed for a major depression that we will not work our way out of until we get that ratio under control.
Fortunately, I’m an optimist. I believe the new Administration will restore some confidence in our financial system. And, I believe they will reduce the deficit by the end of the first term. If we can get back onto the path that we were on in the Clintion administration, there is still time to solve this problem of debt/gdp and avoid a real incarnation of the Great Depression. Of course, it will require hard choices reducing and/or eliminating some of our entitlement programs.
Sincerely,
Matthew
December 12th, 200812:07 pm at
What is your take on the Z.1 report for Q3 released yesterday? The system is leveraging, not deleveraging, thanks to the federal government. Even household nonfinancial debt deleveraging is minimal at -0.8% annualized. I’m guessing that Q4 will look similar with households deleveraging at a slightly faster rate that Q3 but the federal government increasing its debt level at an even faster off-the-chart rate.
What would it take to get debt/GNP down to 150%, especially with the federal government policy of subsidizing current and future losses? What would it take for household debt to be cut in half? The later could semingly only result from massive household bankruptcies and a deep depression.
The federal government’s short-term plan is to attempt to kick the can down the road via levering up the federal government. There is no long term plan. Short-term success under this scenario likely results in a more severe failure sometime in the future.
December 12th, 20081:22 pm at
High debt is a concern but is overblown. The first chart is also misleading. By not showing zero, the chart looks far worse than it is. The first chart almost implies that debt build-up was very quick and massive in the last decade; whereas your second chart shows that this was a slow build over many decades.
Anyway, as for central banks combating bubbles, I would argue that many bubbles are impossible to know in advance. Even if you are not targetting the bubble and simply looking at asset prices to see if credit growth or some other measure is out of control, it is difficult to say. To see what I mean, consider commodities. How many think commodities were in a bubble? I have been bearish so I would say it was a bubble. But I can find many who never considered it as a bubble (they considered it as a natural price increase due to the China-to-da-moon theory). In fact, some still think commodities are not in a bubble and expect prices to skyrocket within a few years. Now, would a central bank look at commodities and interpret that an unfolding bubble? If commodity businesses went out there and issued a ton of debt, backed by the seemingly increasing profits, hence increasing credit in the overall market, would the central bank consider that as a bubble?
Bubbles, and hence booms and busts, are a fundamental element of capitalism. If they were not part of capitalism, they wouldn’t have existed under a free market where interest rates are set by the market (e.g. gold standard, silver standard, etc.) Yet we have had bubbles for a long time. Don’t forget that the Great Depression occurred under a quasi-gold standard. If the free market, which tends to be better, was willing to finance the credit growth in the 1920’s and 1930’s, I don’t see how central banks will determine when credit growth is “too much”.
Lastly, it is easy for market participants to circumvent central banks or governments. The massive increase of SIVs, CDS, and unregulated hedge funds, all of whom are not regulated or lightly regulated, shows how capital can circumvent government control. Some, including me, argue that the US Federal Reserve had very little control of the capital markets, even the US markets and financial institutions, in the last decade. Anyone remember how the long bond yields kept ignoring the FedRes a few years ago?
December 12th, 20083:08 pm at
Kyle,
Perhaps the spike from 1930 on was caused more by the sharp contraction in GDP than an explosion of new debt? Though your question is still valid. Maybe Foremost Depression Scholar Ben Bernanke could answer it.
This chart always boggles my mind…..it feels like debt creation allowed us to consume 3 generations worth of goods in only 25 years.