Everyone knows America has too much debt. What they don’t know is that things are getting better, not worse. Say What?? Do Republicans know this?? Is someone misleading the American Public on the actual RELATIVE debt of the United States?
Little by little, our economy is reducing its debt burden, slowly repairing the damage caused by 10, 20 or 30 years of excess.
If you want to know why economic growth has been so tepid, here’s your answer. Four years after the storm hit, the economy is still deleveraging. And it’s very hard for any economy to grow when everyone is focused on increasing their savings.
Total domestic — public and private — debt as a share of the economy has declined for 12 quarters in a row after surging over the previous decade.
The rapid rise in federal debt over the past four years has distracted us from the big picture. The level of public debt is indeed worrisome, but it’s not as big a worry as the economy’s total level of debt — public and private.
Although we have a whole cottage industry devoted to warning us about the dangers of too much public debt, we don’t have any comparable Cassandras telling us about the dangers of too much private debt. Yet the history of the past 30 years (or 300) clearly shows that too much debt, of whatever variety, can pose a systemic risk to the national and global economies.
As much as we hear politicians, pundits, tea-party patriots and the Congressional Budget Office obsessing about government debt, it was excessive private debt — not public debt — that caused the 2008 financial meltdown. And it was private debt — some of it since transferred to the public — that lies behind the current European debt crisis. (Greece is unique in having a public sector that ran up spending while its private sector is rather conservative.)
As the political rhetoric about the federal deficit has heated up, we’ve lost sight of the progress that’s been made in bringing total debt back under control. The U.S. is actually doing much better than you’d think if you just listened to the conventional fears about how we’re rushing headlong into a debt Armageddon.
In fact, since the recession ended in June 2009, total U.S. debt has risen at the slowest pace since they began keeping records in the early 1950s. While Washington has taken on a lot of debt since then, the private sector has paid off, written off or dumped on the government almost as much.
As a share of the economy, debt has plunged as a consequence of rapid deleveraging by families, banks, nonfinancial businesses, and state and local governments. The ratio of total debt to gross domestic product has fallen from 3.73 times GDP to 3.36 times.
In the 11 quarters since the recession officially ended, total domestic debt has risen by just $702 billion, or 1.4%. By contrast, in the 11 quarters before the recession began, in those bubble years of 2005, 2006 and 2007, total debt increased by $10.7 trillion, or 28%.
And it wasn’t just the U.S., other advanced economies were adding on to their debt loads as well, with most of the debt taken out by the private sector.
Debt was growing at an unsustainable pace, but it was fueling the U.S. and global economies.
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.”
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%.
The deleveraging process in the private sector still has a ways to run, not based on some economists’ rule of thumb, but based on what real people are actually doing. Banks and households are still slashing their debt, while nonfinancial companies are beginning to borrow again, but only a little, according to the latest data from the Federal Reserve’s flow of funds report. Take a look at the flow of funds.
According to a study by McKinsey published earlier this year, U.S. households may have two more years of deleveraging left before their debts are sustainable again.
If McKinsey is right, the U.S. economy may have to endure a couple more years of slow growth.