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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, weve lost sight of the progress thats been made in bringing total debt back under control. The U.S. is actually doing much better than youd think if you just listened to the conventional fears about how were 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 wasnt 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 Reserves 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 Reserves 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."
http://finance.yahoo.com/news/u-debt-load-falling-fastest-040045522.html
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