MORE ON CONSUMER DEBT
Another good perspective on the problem of private sector debt here via Barry Ritholtz’s Big Picture blog. The author shows us an alternative perspective on the continuing balance sheet problem in the consumer sector. The conclusion is similar to our own and shows more clearly how upside down the consumer balance sheet became (and still is):
“The trendline for Debt-to-Income is at about 114% which, absent rising Personal Disposable Income, implies a need to shed an additional $1.5 trillion in liabilities.”
This morning’s uptick in retail sales and the recent expansion in consumer credit has to start making one wonder if we’re not reflating the debt bubble all over again? A true economic expansion cannot be built on the back of unsustainable credit trends. Has all of this bailout mentality and lack of fiscal discipline resulted in a consumer who will become even more careless?
Aggregate numbers hide conflicting internal dynamics. Employment figures show that college graduates have a much lower unemployment rate. They also will find new employment quicker if a job layoff occurs. Also, not everybody is leveraged to the hilt. These consumers had cut back at the start of this recession when layoffs were rising and uncertainty was peeking. Some of the 1.4T in consumer spending reduction was always likely to come back.
The economic stimulus and the slowdown in inventory reduction have stabilized the economy. Workers who still have a job are feeling a bit less concerned although aggregate consumer confidence numbers are still shaky.
The big question is – will consumers, who are still able to spend and borrow, do so in large enough numbers to cover the withdraw of stimulus and the end of inventory re-balancing? another way of asking this is – will the current pick up in spending keep inventory re-balancing going on long enough to cover the withdrawal of stimulus when that starts later this year?
What we do know is, the level of indebtedness has put a ceiling on potential growth. Interest rate policy is less effective on restarting the economy. It will take a long time for the full 1.4T in lost consumer spending to return. Higher taxes and inflation will occur in the medium term.
Here is the statement per The Big Picture regarding the debt-to-DPI ratio:
“The trendline for Debt-to-Income is at about 114% which, absent rising Personal Disposable Income, implies a need to shed an additional $1.5 trillion in liabilities.”
I’ve seen this “trend analysis” a few other places, but it makes no sense to me. Because this is a debt-based ratio, it doesn’t have a trend, but a relationship. Thus, the “trend” in rising debt-to-income cannot and will not rise indefinitely at any increasing rate. Consider what that would mean when it hits 500%.
The trend of something needs to deal with the level, not a ratio. It’s no different than looking at the trend of earnings per share. However, no one would say, “on it current trend, the P/E ratio should rise to 40x over the next decade”.
-Chad
TPC’s chart was the real numbers and shows the same thing. But I agree, these trends are pointless. Where does that line even come from and who says that it is even pertinent to today’s “trending” economy.
This kind of trend line is bogus – what is to say that the trend will be supported forever just because it has shown an increase since the 1950′s? I would argue that between 80% and 100% is the right number (yeah! I know its a large range) – this was the level before all the securitization gimmickry took on stupid proportions and enables the consumer to leverage beyond his capability. So, 114%? Nonsense, 100% – probably sustainable. 90% – makes sense.
Totally agree.
I think Barry is just using the trend to indicate how bad it is … **even** if we kept growing debt/DPI at historical rate we have an enormous mean revision ahead. In fact, even without arguing what is the correct max. debt/DPI one could make the assumption that it is demographically related. I would guess that peak debt happens near apprx. 45-50 years of age which is typically the peak earnings years, and there is enough runway to pay off significant debt (assuming you can keep a job). Whether 114% is too high/low is debatable, but for most countries, the demography won’t allow it to grow and only immigration or government policy will change the inevitable.
TBP folks are bright and certainly understand what we’re discussing, so I won’t disparage them in any of this. it’s just a chart. But as to the issue of debt to DPI, what is the magic level? That is a multi-factor explanation, but some historical norms offer some guidelines. Prior to the parabolic explosion in debt around 1980 or so, it was about half what it is right now. Mean reversion would imply about $7 trillion needs to be eliminated via default, restructuring, or paydown. This is likely to take on the order of a decade, depending on savings rates, incomes, and interest rates – and that’s if we can inflate our way out of this mess (hmm?).
If you look at the”national P/E”, which I estimate using private household plus business net worth-to-national income, we’ve largely deflated the stratospheric section of the asset bubbles. But national valuations are still near the top of any period prior to the last decade, not at all low. Why? Excessive credit creation. The Ponzi finance foundation of debt cannot hold up forever – and then the final cleansing recession will commence…unfortunately. That is what will cure the debt overhang, because the government cannot lever up forever, and a dramatic fall in consumption and investment is really the only pathway from that point (once the government and private sector both attempt to tighten the belt).
incidentally, I hear the Keynesians all the time discuss how the government and private sector cannot deleverage at once. They’re speaking along the line of the savings-investment identity. However, they seem to leave out the other option – deflation. They may not want it, but it I don’t see how we can avoid it.
That chart looks bad. But I am in full support of the decreasing trend of relying on consumer debt to build economic growth. We need to find a better system that does not rely on taking future income (plus interest) to pay for today’s consumption. What’s left when the future arrives?
I understand by supporting a decreasing trend line it would usher in the “final cleansing recession”. When that comes let’s hope we turn to generosity to survive, because there will be a lot of people that will need it.
Keep up the good work,
Eric