Debt Service: First the Silver Lining, then the Cloud

Back in early January, Edward Harrison observed Consumer credit: largest gain in 16 years and well ahead of expectations:

Economic data coming out of the United States continue to show a robust consumer-led expansion.

Harrison gave some numbers, and was optimistic:

Analysts see this not as reflective of distress but buoyancy as the Conference Board’s measure of consumer confidence hit a 17-year high in November. Nomura, for one, released a note saying: “This appears consistent with a strong labor market with low unemployment and elevated consumer confidence, which we expect will continue in the near term.”

Moreover, since consumer spending makes for almost 70 percent of the economy, these numbers bode well for economic growth figures to be released at the end of the month...

Then he dropped the other shoe:

The dark cloud in all of this is the fact that this is debt-fueled consumption.

Yep. But if these signs of economic vigor were fueled by debt, then they should have been predictable -- as predictable as the trouble that will arise from growing consumer debt.

More predictable, even. You might have looked at Household Debt Service two years back and noticed it rounding the bottom:

Graph #1: Household Debt Service as of 3 March 2016

You could have selected the round bottom data, just after the sharp "V" that bottoms out in 2012Q4, and put a trend line on it:

Graph #2: As Above, with Trend based on 2013Q1-2015Q3

You might have said to yourself, "Hey! That thing's going up!"

If you look at where the trend line is in the first quarter of 2018, it seems unrealistically high. But now (two years later) we can ask: How did your prediction turn out?

Right on track:

Graph #3: Same as Graph #2, plus Current Household Debt Service Data (red)

The current data (red) is a surprisingly good match to the path predicted by the trend line.

Of course, the good match does not guarantee that our economy will soon be vigorous again. Still, as Ed Harrison was saying, "Economic data coming out of the United States continue to show a robust consumer-led expansion."

I expect vigor. Vigor until Debt Service costs get too high, and then we lose the vigor.

Why?

You can see Debt Service going up in the early 1980s, after the 1982 recession, when Reagan got that massive spike in Real GDP growth. You can see Debt Service going up in the mid-1990s, when Bill Clinton got what Alan Greenspan called "the new economy":

Graph #4: Household Debt Service (blue) and Real GDP Growth

Debt Service costs went too high in the Reagan years, and that interfered with vigor. In the Clinton years, Debt Service costs stayed between 11.0 and 11.5 until the end of the decade, and the economy's performance was impressive enough that Greenspan gave it a name.

The two datasets are on different scales. However, in both the Reagan years and the Clinton years, the economy regained vigor while Debt Service costs were low, and then economic growth remained vigorous until the blue line went above the other.

Debt Service costs went low again after 2010. Now, though, they are picking up again, and the economy is improving. You could have predicted it two years ago.


I expect our economy to show increasing vigor over the next couple years as Household Debt Service continues to follow the trend line up toward the 11.0 level. Above 11.0, I worry that Debt Service costs will become burdensome and cause growth to slow. I guess we'll have to wait on that and see how things go.

Meanwhile, if you want to play along, take a look at productivity. It too is rising.