"... indebtedness ... has since 1980 jumped ..."

 

Not every quotable line is poetic.

On 16 October I rejected Richard Vague's view that a "debt surge ... resulted in" increase in the debt-to-GDP ratio. Today I have another one -- Benjamin Friedman, from 1986:

The combined indebtedness of both government and private-sector borrowers ... has since 1980 jumped far out of proportion with nonfinancial economic activity.

Indebtedness has jumped, Friedman says. That means debt surge.^[1] Friedman is careful to point out that this increase in debt is relative to GNP.^[2] He says it in the "..." part of the quoted sentence:

[nonfinancial debt] had shown considerable stability in relation to the economy's overall growth [before 1980]

He says it again, in the same sentence, in the words you read above:

[Debt] jumped far out of proportion with nonfinancial economic activity [since 1980]

That's two cautions in one sentence.

 

Caution me all you want, Friedman. I still challenge you to correctly state the cause of increase in the debt relative to GDP ratio in the '80s. You make it sound like debt growth was the problem. It wasn't.

Oh, yes: debt growth most certainly *is* a problem. The problem, I'd say, even before the 1980s. But debt growth was NOT the cause of increase in debt-to-GDP, nor of debt-to-GNP, the increase that you were writing about in 1986. Debt growth was not the cause of that increase. No-sir.

I'll give you the "housing bubble" debt increase, and spot you the covid pandemic debt increase. But debt increase was not the cause of increase in the debt-to-GDP ratio in the 1980s.

 

Suppose we look at nonfinancial debt (TCMDODNS) and GDP (GDPA) in billions of dollars, from 1970 to 1995. This puts the increase in debt-to-GDP -- 1981 to 1986, give or take -- centered on the graph. (The debt number by default is quarterly: end-of-period. I'm using annual: end-of-period.)

Since our topic is the growth of debt and GDP, make the vertical axis a log scale. I love the way the one line parallels the other until it doesn't; and then, again, it does:

Graph #1: Two roads diverged in a yellow wood

Note the little bump at 1981 in the lower line. That's when nominal GDP started slowing in response to anti-inflation policy.

I brought the data into Excel, added exponential trend lines based on the years 1970-1981, and made the vertical axis a log scale. The trend lines straightened out nicely, and the plotted values cling to the trend lines in the 1970-1981 period. Note that GDP drops below trend immediately after 1981, while debt clings to trend until 1984:

Graph #2: I love how the exponential curves straighten out on a Log Scale graph

This graph shows that debt actually did go a little above trend -- this is not what I've been saying-- that debt did "surge" a little (if there is such a thing as a "little" surge). And I may have been a little too rigid if I said the 1981-1986 increase in the Debt-to-GDP ratio was due entirely to the decline of nominal GDP, and not at all to debt. 

However ...

NGDP reacted first to Volcker's anti-inflation policy; debt reacted only after a lag. Contrary to what I have been saying, it seems that both NGDP and debt may have been involved in increasing the debt-to-GDP ratio. I am still tempted to argue that "GDP was primary and debt was secondary". This sounds good to me; but really it would only mean that GDP reacted first and debt reacted later.

 

Here's another look at the Excel graph, turned to make the trend lines horizontal:

Graph #3: The Turned Graph. Some things are still easier to do on paper!

In this view it is more obvious that GDP reacted before debt. Also, the lag (before debt reacts) looks longer than I thought. But I have to say that an increase in debt doesn't strike me as a reaction to anti-inflation policy. So, okay, maybe that increase was a "surge" in debt. 

But if it's a surge, it looks like a mini-surge. A very small surge. And looking at graph #3, I think I can still say, at the very least, that the first half of the increase in the debt-to-GDP ratio was due to the slowdown of GDP, not to any "surge" in debt growth. In other words, the debt surge may have contributed to the debt-to-GDP increase, but the slowdown in NGDP growth caused that increase. (I'm still saying "debt surge" was NOT the cause of the 1981-1986 increase in the debt-to-GDP ratio.)

I notice also, after the 1981-82 drop of GDP below trend, a second drop. This second drop in GDP occurs at the same time as the mini-surge in debt. The timing and shape of the 1984-85 movement of the two lines away from trend, in opposite directions, suggests that the increase in debt growth contributed to the decrease in nominal GDP growth, and perhaps also in real GDP growth.

And, well, yeah, isn't that what the Debt-to-GDP ratio is all about.

Still, saying the increase in debt caused a decrease in GDP growth is a far cry from saying that a "surge" in debt created an increase in the debt-to-GDP ratio and that this increase stands as evidence of financialization's ultimate conquest of the nonfinancial economy. 

And miles to go before I sleep.