Friday, April 20, 2012

It's About Debt, Stupid!

Much has been made during the recent economic recovery, which began in July 2009, about the excessive debt loads faced by small businesses and households.  The high debt levels have been given as a contributing factor to the economic collapse in the United States that appeared late in 2007.  In addition, these high levels of debt have been associated with the slow economic recovery

One of the major books published during this time period has been the work of Carmen Reinhart and Kenneth Rogoff titled “This Time is Different.”  The research presented in this book highlights the role that debt can play in the collapse of an economy and the subsequent slow recovery associated with debt-related economic crisis. 

Well, some good news is coming to us from the household sector.  It seems as if households are achieving some success in reducing their debt payments, which will allow them to continue to reduce their debt loads and increase their consumption expenditures.

“The Federal Reserve estimates that the household debt service ratio, a ratio of debt payments to disposable personal income, fell to 10.9% in the final three months of 2011 as a result of low interest rates and reduced debt levels.  That was the lowest reading since 1994.  Total financial obligations, which add in rent payment, homeowners insurance and property tax payments, were 16 percent, the lowest since 1984.”  This is an article by Floyd Norris in the New York Times ( 

Norris writes, “debt levels have fallen.  Over all, households owe about $13.2 trillion, nearly $600 billion less than in late 2008….low interest rates mean that servicing that debt costs less.  The Commerce Department says that mortgage interest payments, in dollars, are lower than at any time since 2005.”

Norris continues, “In this country, the deleveraging process has some way to go, with many foreclosures still pending….”  And, “To get the deleveraging process under way, it is important for lenders to race reality, admit losses and deal with them.”

Not all the reduction of debt has been voluntary: “”The McKinsey Global Institute estimates that about two-thirds of the reduction came from the cancellation of debt, through writeoffs and foreclosures.” 

Debt reductions, however, are debt reductions.  According to Reinhart and Rogoff, deleveraging is something an over-leveraged economy needs.

That is, these statistics are a positive sign. 

Furthermore, commercial bank lending has finally begun to rise.  This may sound contradictory to the above comments, but the crucial thing is that the bank lending is coming in areas that relate to business and not to the consumer and can be a positive contributor to economic growth.  In fact, this kind of loan growth is necessary for economic growth to be sustained, even if at a modest 2.0% to 2.5% rate. (See my post “Loan Growth Continues to Pick Up at Commercial Banks,”  I take this to be a good sign.

Finally, let me just add that I don’t perceive that economic growth will become robust for a little longer.  But, this does not mean that economic growth will not continue even at a tepid pace.  Analysts wring their hands over the latest numbers on the jobless claims and other recent indicators of the employment situation. (  The situation in the labor market is very worrisome.

However, the situation in the labor market is not just a short-run problem.  As I have pointed out numerous times over the past two years the un-employment rate is not the crucial one at this time.  The crucial indicator of the situation in the labor market is the under-employment rate.  I place this rate at around 20 percent of the eligible workers in the country.

There have been several articles recently in the daily press that discuss this point.  One of the better ones is “A Workforce on the Wane” in the Financial Times. (

Furthermore, it is not only in the labor market that we find an under-utilization of resources.  The capacity utilization in the manufacturing sector rests below 80 percent.  Before economic really begins to pick up in the future, businesses are going to have to deal with their surplus capacity, something that has steadily been growing since the 1960s. (

Dealing with under-employment and with under-utilization of capital is a long-run problem that must be dealt with over time.  The problem is, that as long as there are so many potentially productive resources out-of-line with what is needed in the economy, economic growth will remain slower than we would like it to be.  Re-training and re-structuring must be accomplished before higher growth rates can be sustained. 

The news on debt loads and debt levels is encouraging.  The direction begun must continue.  It is good that the commercial banks have stepped up this business lending for this is needed to underwrite the meager expansion that has already begun.  But, this is a long-term affair and efforts to try and get too much out of the recovery too soon will only make the future more precarious. 

No comments:

Post a Comment