This may very well be the most important data point that we are currently receiving every quarter.  Yesterday’s Z1 released by the Federal Reserve showed a continuing decline in household credit.   The latest reading showed a -2% decline in total household debt growth versus last year.  The Fed summarized the data:

“Household debt declined at an annual rate of 2 percent in the first quarter; it has contracted in each quarter since the first quarter of 2008.  Home mortgage debt fell at an annual rate of 3½ percent in the first quarter, ¾ percentage point more than the decline posted last year.  Consumer credit rose 2½ percent at an annual rate in the first quarter, the second consecutive quarterly increase.”

Total household debt continues to decline

Frustratingly, I’ve been discussing this dynamic for well over 2 years now.  In early 2009 I wrote about why this wasn’t the banking crisis that Ben Bernanke thought it was, why the aid package would likely fail to help Main Street (it focused too much on Wall St) and why we were remarkably similar to Japan:

“Unfortunately, our leaders have misdiagnosed our problem as a banking crisis and not a Main Street crisis.  We have ignored the real root cause of the problem which lies not with the bank balance sheets, but with the household balance sheets.  As I have long maintained, we are looking more and more like Japan and the balance sheet recession they suffered.  While we ignore Main Street in favor of Wall Street it’s likely that the recession on Main Street will endure….”

Being a consumer driven economy this decline in debt remains the most important component of our economic plight.  As I’ve previously explained, the collapse in consumer debt has been the primary cause of weak economic growth.  Consumers took on excessive debt levels during the housing boom and when housing prices collapsed their balance sheets were turned upside down.  Consumers were left with excessive debt, collapsing aggregate incomes and a subsequent balance sheet recession.  The overall result is that consumers are still working to pay down this debt and remain in saving mode as opposed to debt accumulation and spending mode.

This is a highly unusual event that has only been seen on rare occasion in developed economies over the last 100 years.  As this process occurs there is only one entity that can help to stabilize the economy – the US Federal government.  As we know from the sectoral balances, when the private sector is in saving mode and not spending mode (due to debt reduction) and the current account remains in deficit, there is only one sector that can offset this weakness in an attempt to create economic growth.  That is the public sector.  Thus far, we’ve managed to fend off the austerity chatter, however, the risks appear to be on the rise as government officials become convinced that the United States is bankrupt (something that is fundamentally impossible).

This is the exact situation we have seen in Japan for the last 20 years and it is currently occurring in much of Europe.  If the United States implements a policy of austerity there is little doubt that the economy would continue to contract again, unemployment would increase and the economic malaise would worsen.  By my estimates, this situation is likely to persist well into 2012 and perhaps longer depending on how the economic environment progresses.


* Addendum 1 - It’s important to note that the consumer debt reduction process is a good development.  It is necessary to help build the foundation for a sustainable recovery.  Consumer debt accumulation in moderate levels should been seen as a good thing.  Unfortunately, it was the excessive debt binge that caused our current predicament.  As this process heals over the years we should embrace it and accept it as a necessary part of the natural economic progression following a debt bubble.  That requires a unique policy response and a particularly important need to focus on Main Street’s woes and not Wall Street’s woes.

** Addendum 2 – Because monetary policy works largely to increase the debt levels and by helping the banking sector, it can actually be detrimental to this natural healing process during a balance sheet recession.  This is why we should reject further Fed intervention in the markets and encourage Congress to look into potential aid packages such as a reduction in taxes.

*** Addendum 3 – Scott Fullwiler wrote a spectacular piece on sectoral balances here.  This should really help clarify what is going on today.  Scott Fullwiler for Treasury Secretary?  :-)

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  1. Do you know the difference between correlation and causation?

    I wonder….

    I really wonder…

    I have yet to see you actually provide any proof of your theories. It seems you take your own affirmative statements as proof.

    And no, austerity is nothing but a code word for bend over little guy as your social betters prepare to rape you.

    Maybe if you were congruent in some way with your thinking and writing, it would make more sense. But I think you need to understand it is not advisable to put mutually exclusive statements in the same paragraph.

    And back to your record of accurate calls… I can find none. Must be all in your mind.

  2. I am not impressed with your paralogisms and specious attempts to have it both ways on monetary and fiscal policy. Others may not see your inherent illogic, but it is clear as day on this side of the keyboard. The problems with your premises are the contradictions that must escape you. So, hoping you’d find your own way to your fallacies, I will just break it down this way, in the simplest possible form…. Do I need to bring along flash cards and finger paints?

    You advocate government spending as a solution to everything. In this, you assume to use the current fractional reserve central banking system to facilitate government spending, after all, who provides government with their funds? Since as you say it is not tax dollar (I have no time for this one right now), do you presume to create the government currency through the use of a central bank? Oh, I know your kind. You will just do it correctly, your school of thought will be the gentle stewards all the plebs need. The loving guiding hand? Sound about right so far chief?

    In planning to use a central bank apparatus to fund government operations, you are a central planner and only arguing for more of the same. The same situation that creates the “business cycle” will be replicated with all its horrific distortions and lives shattered under your school’s thumb. So are you a Communist, a fascists or just ignorant? I see nothing in the US Constitution speaking of such a central banking system, I do however know state allocation of capital through a central bank is a plank of Communism. I know no man who can appropriately issue debt to meet the needs of all the diverse and distinct LOCAL production cycles (the fatal flaw in any central bank – CENTRAL, get it? Where does production and the economy take place? Hint, since you need it, it ain’t CENTRAL – I digress)

    Yes, yes… you can call your religious belief system, your ideology fancy sounding things such as modern monetary theory, but it is nothing new and not a solution. It certainly isn’t as your falsely advertised website would have me believe, “pragmatic capitalism”. Not in the least.

    • You’re still at it, huh? What happened to you being so important and having real work to do and not having the time to read anything here or being too important to leave comments? Should we assume by the length and weakness of your arguments that you’re not that important after all?

      • Patience, Cullen! The guy, as you noticed, obviously needs to vent. When he’s done, he just might actually – you know – read what you’re saying and think about it for some time. Then after he starts appreciating MMT – and I’ve seen people doing that more often than not – to spare himself the embarrassment, he might be back under a different nick and post here as a supporter!
        this one is priceless:
        So, this is a recession (sic) caused by a lack of debt based consumption. So, the obvious solution it to restart debt based consumption bubbles?
        Hmmmm, you really need to stop making a fool of yourself – this is 180 degrees opposite of what MMT advocates. By the way, stop over at Warren Mosler site too. Go thru the manadatory reading, if you’re so open-minded as you claim. It might just dawn on you that you had no idea what MMT was.

        • Isn’t that great? He admits to not even reading half of the content or comments and then lays into me as if he knows what’s going on. Priceless.