Household debt: An Alternative to the Wikipedia View

All of the Wikipedia references in this essay have been taken from the "Household debt" article on the evening of 9 April 2021.

 The opening statement:

Household debt is defined as the combined debt of all people in a household. It includes consumer debt and mortgage loans. A significant rise in the level of this debt coincides historically with many severe economic crises and was a cause of the U.S. and subsequent European economic crises of 2007–2012. Several economists have argued that lowering this debt is essential to economic recovery in the U.S. and selected Eurozone countries.

"A significant rise in the level of this debt" -- household debt, as opposed to government debt, nonfinancial business debt, and financial business debt -- "coincides historically with many severe economic crises..."

I am particularly uncomfortable with the view that household debt is the problem. Such analysis is, at the very least, oversimplified.

 

Under Historical perspective:

In the 20th century, spending on consumer durables rose significantly... Easy credit encouraged a shift from saving to spending.

No. Policy encouraged the shift from saving to spending; easy credit was only one aspect of policy.

Under Global economic impact:

"Household debt soared in the years leading up to the Great Recession. In advanced economies, during the five years preceding 2007, the ratio of household debt to income rose by an average of 39 percentage points, to 138 percent...

Yeah, okay. I don't know the specific percentages, but rapid debt increase leading up to 2007 is right. On the other hand, it is wrong to grab one fact and start drawing conclusions. Just as the financial crisis and Great Recession were consequences of massive, rapidly growing household debt, so too was the massive and growing household debt a consequence of that which came before.

We cannot wait until the shit hits the fan and then say Now there's the problem! We must not wait until it is too late. If accumulating debt leads to accumulating disaster, the time to act is not at the first evidence of disaster but at the first indication that growing debt is starting to slow the economy. Not in 2007, in other words, but in 1967.

Under U.S. economic impact: 

The policy prescription of Ms Yellen's predecessor Mr Bernanke was to increase the money supply and artificially reduce interest rates. This stoked another debt and asset bubble.

Note carefully that those sentences attribute both the solution and the problem to the central bank.

The central bank operates in an economic environment created largely by the U.S. Congress. The U.S. tax code for many many years, by allowing the tax deduction for interest paid, encouraged people to go into debt and to remain in debt. Only when debt had grown to the point that it was creating problems did Congress begin to eliminate the tax deduction. It was half-hearted. It was ill-conceived. And it came too late.

Eliminating the tax deduction at a time when debt was already creating problems only made the problems more severe. You would have had to eliminate the deduction by the early 1960s to beat the clock on this, and the fact that you don't believe that is part of the reason it didn't happen.

In any event it would have been better to replace the tax deduction for interest paid with a tax credit that reduces our tax payments when we pay down our debt ahead of schedule. Such a policy could be designed to create the same tax advantage for the taxpayer, while improving macroeconomic conditions by reducing our debt.

And this:

Economists Atif Mian and Amir Sufi wrote in 2014 that:

• Historically, severe economic downturns are almost always preceded by a sharp increase in household debt.

Again, we don't want to wait until the severe economic downturn is right on top of us.

And again, looking only at household debt gives us an incomplete picture. Here is household debt as a percent of GDP:

Graph #1: Household Debt as Percent of GDP

On the first graph, household debt appears to reach a horrifying high just in time to cause the Great Recession. But now look at that same household debt as a percent of All Sectors debt:

Graph #2: Household Debt as Percent of All Sectors Debt

Relative to the big debt number, household debt reaches its lowest peak just before the Great Recession. High peaks occurred in the mid-1960s when the economy was still good, but on the cusp, and in 1980 when the economy was already slowing due to excessive debt.

Look only at household debt and household debt looks like the biggest problem in the world. Compare household debt to all the debt, and you know in your bones that the problem does not lie in one piece of our massive accumulation of debt, but in the whole of it.

Under Effects on economic growth they quote Ezra Klein:

The utility of calling this downturn a “household-debt crisis” is it tells you where to put your focus: you either need to make consumers better able to pay their debts, which you can do through conventional stimulus policy like tax cuts and jobs programs, or you need to make their debts smaller ...

Number one: IT CANNOT BE DONE THROUGH CONVENTIONAL POLICY. Conventional policy is based on two notions, one true, one false:

• using credit is good for growth; and 
• the resulting debt does no harm.
  

The problem will not be solved by conventional policy until the conventions change. 

And remember, if the problem is debt, look at the whole problem, not just part of it. And when the problem is big enough to grab everyone's attention, the economy is telling you the problem has been growing worse for a very long time.

If anyone would know, she would

 

"Friedman rejected cost-push as a credible source of sustained inflationary pressure."

- Anna Schwartz

 

Interest-cost-push: Changes in interest cost NOPE, FORGET IT

Nope. I can't do it. Can't figure it out. I can't even tell if I'm close to right, or off by a mile. I will leave the post available, in case I need it.

The first two graphs are okay. It's the third graph, where I got inventive, that's the problem. That graph wants to show the percentage of a change in interest cost that is due to a change in interest rates. After finishing the graph, I posted the post and then started on a graph to show the percentage of a change in interest cost that is due to a change in outstanding debt.

I got another low percentage. Not as low as on Graph #3, but low. I should be able to add the part that's due to a change in interest rates and the part that's due to a change in outstanding debt, and get an answer that is equal to the change in interest cost.

Not even close.

I'm looking for evidence of cost-push inflation. Specifically, financial cost-push arising from the cost of interest.

"interest was definitely an increasing cost in those years"

I'm looking at the years before 1965. Before the Great Inflation. I'm looking for subtle but persistent increase of interest costs -- something one can find almost everywhere. I want to see the growth of interest cost relative to income (for households, disposable personal income), and in the business sector relative to profit or employee compensation costs or whatever makes sense when I get that far into it.

For households there is data going back to 1980, data on debt service (interest and principal payments) as a percent of disposable personal income (DPI). So I assume DPI is the appropriate context variable to use for my interest cost study.

The "Monetary Interest Paid" data for households is annual data starting at 1946. One version of this data is for households alone. Another version, which I used in the first graph, is for households and nonprofit organizations. I'm going to have to end up using the "households and nonprofits" version to be compatible with data that's called "household debt" but includes the debt of households and nonprofit organizations. For the next graph, I'll show both versions of the household interest cost, so you can see how nearly equal they are.

I'm using the annual version of  DPI, which goes back to 1929. The graph starts at 1946, where the interest data starts:

Graph #1: Household Interest Cost (two measures) as Percent of DPI 1946-1970
Note that the increase suddenly stops in the mid-1960s as
wages finally started participating in the wage-price spiral

Interest costs rose from roughly 1% of DPI in 1946 to 2% in 1952, to 3% in 1956, to 4% in 1962. Roughly. It's not exponential growth, but interest was definitely an increasing cost in those years. From start-of-data (1946) to the start of the Great Inflation (1965), interest cost increased by about 3.33% of disposable personal income (and DPI was itself growing at the time).

This interest cost increase works out to an average annual rate of increase of about 0.175 percent over the 1946-1965 period. Over three years, more than half a percent. Not a big number, but the increase was persistent. Subtle, but persistent.

The two lines, by the way, are very close. Nonprofit organizations add almost nothing to the household debt number. I'm going to drop the household-only data and work with "household and nonprofit".

I want to look at how much of the increasing interest cost was due to rising rates and how much was due to the growth of debt.

My method is to estimate interest cost for a given year based on the effective interest rate from the year before. I expect the change in interest to be proportional to the change in debt outstanding. Any discrepancy between expected interest cost and the given year's actual interest cost is attributed to a change in interest rates. 

The graph shows the portion of the change in interest cost that is attributable to a change in the effective interest rate: NOTE: It may not show that. I'm not sure now. I have conflicting graph results.

Graph #3: Rising Interest Cost is due mostly to Growing Debt, not to Rising Interest Rates

Before 1966 or so, interest cost due to rising rates averaged by eye a little above zero. From the latter 1960s thru the early '80s, inflationary years, the average ran closer to 5% of interest cost. After the early 1980s when the debt numbers were big and interest rates were falling, the portion of interest cost due to rising rates averaged a few points below zero. Nothing surprising there. My evaluations, however, like my averages, are only by eye.

As an indication of relevance: The deepest low, around 2001-2004, I think that's the same years John Taylor is talking about when he says interest rates were "too low for too long". 

 

More to come on the topic of financial cost-push and the cost of interest.

Occam's possibility

Real Time with Bill Maher, S19E10, 3/26/2021, with Brett Stephens, Caitlin Flanagan, Christopher Krebs.

In the monologue, Maher mentions the $3 trillion infrastructure spending proposed by President Biden. At the table he mentions it again. 

Brett Stephens replies three trillion is a lot of money. He makes reference to Brewster's Millions, where Richard Pryor's character "has to spend $30 million in thirty days, in order to inherit $300 million." Not sure what Stephens's point is, other than it's a lot of money.

Maher likes Biden's plan as "a Trojan horse for green energy".

In the New Rules part of the show, Maher says:

... looking at the economic factors right now, it feels like we're back in that head space that we'll never run out of cash as long as the Fed doesn't run out of ink.

He doesn't like the government spending. Still, he likes the Trojan horse for green energy.

I watch Real Time regularly. Maher is often very good, especially in the "New Rules". He is also often very wrong. For me, with my focus on the economy, Maher is often wrong about the economy.

He says things well. His line about running out of ink was good. But other than Maher's word choice, there is nothing new or interesting in what he said. It's the same old tiresome economic nonsense, dressed in a clown suit.

Here's the way our monetary system works: 

• The Fed loans money to banks so the banks can lend money to businesses and consumers. Businesses and consumers borrow. In addition, government borrows from people who have money that they don't need to spend. All this borrowing puts money in motion in the economy, and also creates a lot of debt.
• With all of that money in circular flow, there is money enough that debtors can grab some of it, pay off some debt, and reduce both the money and the debt in the economy.
• Some of the money in flow drops out of flow when people have a chance to save. Some drops out when we import stuff and pay for it. Economists say also that some money drops out of the flow when the government takes it in taxes. But you don't get to use that excuse if government spending is always in deficit.
• These changes to debt in the economy and money in flow happen repeatedly over many decades with no apparent problem. All the while, however, money is dropping out of flow, leaving more and more debt with no corresponding money that can be snatched from the flow and used to pay down debt. Over time it becomes more and more difficult to find the money to pay the bills. Of course we can always borrow more money if we need it. But that creates more debt. It does not solve the problem.
• Eventually, our bill-paying troubles grow severe enough that one unpaid debt can start a cascade of unpaid debts, and then you have a financial crisis.
  

That's how that all works. There's not really a problem that can be fixed by balancing the budget.

Graph #1

Hey, I don't like it either, the Federal debt going up so fast. But you know, I'm less prone to complain about the growth of debt than I am to say Graph #1 doesn't show the growth of debt. It shows the size of the Federal debt.

Graph #2 shows the growth that debt.

Graph #2

It's the same data, same graph as #1, except on #2 the vertical scale is a log scale, so the line takes a different shape and the graph shows growth instead of size.

#1 shows a lot of increase in the past 10 years. #2 shows increase but no acceleration (no curving upward) in the past 20 years. That's important. We're doing something wrong that makes debt increase, but at least we're not making it get worse faster. The line isn't curving upward.

Neither graph, by the way, shows how debt grew in response to covid. As of this writing, the data ends in 2019.

There are dangers that arise from our growing Federal debt. Most people who worry about it worry that it creates other problems for our economy, problems like inflation and crowding out. I'm sure there's a long list.

Such things are possible. But I would point out that a bigger problem is the "expectations" created by people who worry vigorously about the Federal debt. Worry about the Federal debt spreads because the worries are repeated so often. The growing worry can eventually create the problems that people fear. The same principle says inflation can be created by "inflation expectations" -- and economists warn of that one all the time. Debt expectations are just as real, but almost always ignored. That's troubling.

I prioritize the problems arising from Federal debt thus:

Low: Inflation, Crowding Out, Slow Growth, etc., caused by the debt.
Medium: The creation of expectations that lead to such problems.
High: The growing debt shows that we do not have control of the situation.

My strongest argument for containing the growth of Federal debt is simply to show that we can do it, to demonstrate that we have control of debt. Showing that we have control would solve the expectations problem.

Unfortunately, most people seem to think we know how to solve the debt problem, and we lack only the will to do it. That's nonsense. We've been trying to solve the debt problem since Reagan, without success. Forty years of failure. Forty years, maybe more. 

To make matters worse: The longer the Federal debt problem continues, the more people become committed to their debt solutions that don't work. Another word for that sort of extreme commitment is polarization.

 

In an old episode of Real Time (S17 E1, 18 Jan 2019), Maher said:

I don't really think there is a great need for new ideas because we've been around the same problems for decades. So we know what the ideas are. It's the political will to put them into play.

and John Kasich replied

I don't disagree with that.

I do. I disagree with Maher. His view is that "we've been around the same problems for decades" but we still haven't solved them, so we must not be trying hard enough. 

Maher does not see Occam's possibility: that our solutions don't work because we have the wrong solutions.

Maher and people like him -- most people -- think they know what the solution is. They do not. Nor do the people on the other side, the ones who say the Federal debt is not a problem and the government should spend whatever it takes to improve the economy. Those people want to put the upward curve into Graph #2. That's not a solution.

We misunderstand the economy. We do not know what the real problem is, and we're not trying to solve it. We're trying to solve the consequences arising from that problem. We do not understand that they are consequences. We do not wonder what problem they might be consequences of. The real problem remains, its consequences remain, and all our solutions come to naught.

Bill Maher's view -- we need to try harder -- is a commitment to failure. Maher is unwilling to re-evaluate things. He is unwilling to consider changing our problem-solving strategy. He only wants to try harder. He wants to continue using a strategy that has not worked for 40 years, and just try harder.

The trouble with Maher's approach to solving economic problems is that it is open-ended: As long as the problem is not solved, his solution is only to try harder. But if the problem you're trying to solve is a consequence of the real problem, you will never solve it. Because you cannot solve consequences.

The effective interest rate

If I have three different loans at three different interest rates, I can take the total interest I pay during a year and divide it by my total debt to get something called the "effective" interest rate.

My dumb-ass way of doing it is to take the total interest cost for one year, and divide it by the total debt I owe in the same year. Because it's easy to do at FRED, and I never thought twice about it.

But after making a lot of graphs showing debt, I know that debt totals are given as "end of period" data -- typically, the end of the year, or the end of the quarter. And thinking about it, it doesn't seem right to divide this year's interest cost by the amount of debt I will owe at the end of this year. I pay interest on what I owe, not on what I'm gonna owe.

The interest I owe this year is based on the debt I owe since the start of this year (or the end of the year before). I should divide this year's interest by the debt I owed at the end of last year. Thinking about it, I think that's right.

I should say, though, that I didn't think of it on my own. I read about it recently in an old PDF, the Fisher Dynamics PDF by Mason and Jayadev. On page 10 they write:

the effective interest rate [is] computed as the ratio of total interest payments to the stock of debt

 and on the following page:

The effective interest rate i is total interest payments divided by the stock of debt at the beginning of the period.

Or, since debt is measured as "end of period" totals, the effective interest rate is "interest paid" as a percent of "debt outstanding at the end of the year before."

But at least, now that I thought it through in my own way, I should be able to remember it. And since what I'm thinkin does correspond to the Mason and Jayadev calculation, I think I have it right.

Now what I want to know is: Does it make a difference? So I'm off by a year, so what?

I got the data for household debt from FRED, which is actually liabilities of "households and nonprofit organizations". Then I got the interest paid data for households and nonprofits. Then I moved the data to Excel:

Dividing this year's interest cost by last year's debt number gives a consistently higher effective interest rate than you get with the "same year" calculation. Yes, it makes a difference.

The orange line being higher means that I'm dividing by a smaller number: by a consistently smaller number. In other words, last year's debt number is consistently smaller than this year's debt number.

Yeah that's true. Our debt is growing all the time.

So the effective interest rate is higher than my "same year" calculation says, because debt is growing. This conclusion is confirmed by the graph since 2008, when the growth of debt suddenly slowed: The gap between the lines closes.

So much for the quantity theory of money

Of the 68 "monetary base" data series FRED lists for the United States, 64 of them have been discontinued.

Why does Google equate "empire" with "civilization"?

What -- We're not a civilization until we develop into an empire? Give me a break! The whole of "empire" is the decline-and-fall stage of civilization.