Presentation to The Global Interdependence Center Steve Clemons and Richard Vague www.debt-economics.org

2/12/13

The Raging Debate Between Stimulus and Austerity on Public Debt Debt to GDP Debate tends to omit discussion of private debt

300

250

200 Blue — Federal Debt Red — Private Debt

150

100

50

0 1945

2011

Rapid Increase in Private Debt Caused the Great Recession

U.S. Home Mortgages as a percent of GDP (in percent)

$2.5 trillion in excess mortgages vs trend line

80

RUNAWAY LENDING! 68% growth in ten years and 46% growth in six years

70

60

50

Average 16% growth in previous four decades

Higher asset values not a mitigant, true constraint is income

Mortgage Loans/GDP Mortgage Loans if Continued 16% Trend

40

30

Inevitable spate of non-payment after a period of binge lending brought the Great Recession

20

10

1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

0

4

Why Does High Debt to GDP Matter? • If a home or business owner has high levels of debt, reduced capacity for additional spending and investment • In aggregate, a country’s capacity for growth is constrained if its citizens and businesses collectively are operating at high leverage • Though borrowing equals lending, borrowers and lenders are largely different groups, and income is the ultimate constraint on lending

2011 Comparison of Economic Categories (in billions) $30,000

$9 trillion growth in the last ten years

$25,000

$20,000

$15,000

$10,000

$5,000

$0 GDP

Non-Financial Private Debt

Total Public Debt

Money Supply

Trade

Tax Receipts

6

GDP growth correlates more to private debt growth than government debt growth U.S. Growth in GDP, Private Debt, and Public Debt 1970-2011

Japan Growth in GDP, Public Debt, and Private Debt 1990-2010 12% 10% 8%

-5% -10%

Also correlates more than M2, trade imbalances

2010

2008

2006

-2% -4% -6% -8%

2004

1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009

0%

2002

Growth in Public

2000

5%

Growth Public Debt 1998

Growth in Private

1996

Growth in GDP

10%

Growth GDP

6% 4% 2% 0% 1994

15%

1992

20%

1990

25%

Growth Private Debt

Analysis tends to look to the liability side of private balance sheets and other other variables, rather than asset side of the balance sheet

If runaway private lending caused the Great Recession, did it also lead to the Great Depression?

Nominal Private Debt Totals 1919-1935 (in billions)

Private Debt to GDP Trends prior to the Great Depression and Great Recession (in percent)

$180

66% growth 1919-1929

200

Runaway Lending: 40% Private Debt to GDP Growth

$160 180 $140 $120

160

$100 140

$80

Private Debt/GDP 1920-1930

$60

120 Private Debt/GDP 1997-2007

$40 100

$20

1919 1920 1921 1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935

$0 80 1

2

3

4

5

6

7

8

9

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11

9

If the 1920s and 2000s had 40% private debt growth, how many OTHER times in the last century has private debt growth been 40% in a single decade?

2009

2006

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2000

1997

1994

1916

1991

1988

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1982

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1967

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1961

1958

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1949

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1937

1934

1931

1928

1925

1922

1919

1916

KEY GRAPH: Private Debt and Public Debt to GDP 1916-2011

250 (in percent)

2011

200

150 Private/GDP

100 Public Debt/GDP

50

0

Only Three Periods with Very High Debt Growth Private Debt to GDP 1916-2011

250

Only three periods of private debt to GDP growth of 40%

(in percent)

200

150

Private Debt to GDP 100

50

2009

2006

2003

2000

1997

1994

1991

1988

1985

1982

1979

1976

1973

1970

1967

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1931

1928

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1916

0

12

Only Two Periods with 150% Private Debt Levels Private Debt to GDP 1916-2011

250

Only two periods with 150+% absolute private debt to GDP

(in percent)

200

150

Private Debt to GDP 100

50

2009

2006

2003

2000

1997

1994

1991

1988

1985

1982

1979

1976

1973

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1916

0

13

Combining the Two is Predictive Private Debt to GDP 1916-2011

250

Only two periods with private debt to GDP growth of 40% and 150+% absolute private debt to GDP

(in percent)

Reagan Revolution

200

Good Times 150

VOILA! Private Debt to GDP

100

50

2009

2006

2003

2000

1997

1994

1991

1988

1985

1982

1979

1976

1973

1970

1967

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1961

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1916

0

False comfort from low interest rates 14

• GOOD NEWS: we now have a tool for predicting — and preventing — the next major crisis of this magnitude • But how did we miss something so obvious? • Because many prevailing economic theories and forecasting models ignore debt altogether — since debt is “net zero” • In addition, we missed it because it is widely held that debt growth is always bullish — witness the commentary about increased home ownership in the 2000s and the welcome we give loan growth today — and it is the objective of monetary stimulus

• WE ARE STILL WELL ABOVE 150% PRIVATE DEBT TO GDP — and growth is harder when you have high debt • SO HOW WOULD YOU ADVISE DECREASING OUR HIGH RATIO OF DEBT? – – – – –

Pay down debt Getting government debt under control Growth or Inflation Debt restructuring Live with it

Nominal U.S. GDP, Private Debt, and Public Debt 1920-1939 (in billions)

$180 $160 $140 $120

Private Debt $100

GDP Public Debt

$80 $60 $40 $20 $0

1920 1921 1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939

• Treasury Secretary Andrew Mellon advised President Herbert Hoover to “liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate … it will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people.” • He advocated weeding out “weak” banks as a harsh but necessary prerequisite to the recovery of the banking system. This weeding out was accomplished through refusing to lend cash to banks or put more cash in circulation.

• The single biggest lesson of the Great Depression for economists was to AVOID major debt pay down — a “liquidity crunch” • Thus, in the 2000s, we again had runaway lending, but no massive debt pay down after the crisis point, so instead of private debt contraction of 25% and unemployment of 25%, it was 3% and 9%

U.S. GDP, Private Debt, and Public Debt Trends 1998 to 2011 (in billions)

30000

25000

20000

Private Debt 15000

GDP Public Debt

10000

5000

0 1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

•

We avoided Depression, but we have a NEW DILEMMA, a heavy overhang of personal and business debt, so they do not have as much capacity to lead vigorous growth

•

EUROZONE CRISIS is also about runaway private debt

•

Runaway lending happened in Japan in 1991 — almost 40% in ten years then a crash — and 22 years later Japan’s economy has barely grown, with private debt still at 150% of GDP. Once the world’s second largest economy, Japan is now a lackluster third

1991 Japan Crisis, GDP Trends, and Private & Public Debt 1980-1999 (in billions)

¥1,200,000.00 ¥1,000,000.00 ¥800,000.00 GDP

¥600,000.00

IMF Public Debt Total Private Debt

¥400,000.00 ¥200,000.00 ¥0.00 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998

Almost all countries are on this steep path of increased leverage Total Debt to GDP of Select Countries 1980-2010 400% Italy

350%

France

300%

Available borrowing capacity should be included when measuring a nations wealth

Germany

250%

China 200%

Brazil

150%

United States

100%

Japan 2010

2007

2004

2001

1998

1995

1992

1989

1986

1983

1980

50% 200%

Debt Net of Deposits 1980-2010

180% 160% 140% 120% 100%

80%

US Japan Germany France Italy Spain

60% 40% 20% 0% 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

The Real Story in the Eurozone Private Debt to GDP 1980 to 2010

250%

200%

150% Spain

100% Italy

France

Germany

50%

0%

Between Scylla and Charybdis • Deleveraging contracts GDP

• Re-levering promotes growth, but increases the structural precariousness of the economy and dampens future growth

Another observation: Global growth is slowing Percent Change in GDP in international dollars

Inversely related to debt accumulation

80.00%

70.00%

60.00%

50.00%

1950-1960 1961-1970 1971-1980

40.00%

1981-1990 1991-2000

30.00%

2000-2008 20.00%

10.00%

0.00%

World

USA

Euro 5

BRIC

Rest of World

• SO HOW WOULD YOU ADVISE DECREASING OUR HIGH LEVELS OF DEBT? – Paydown — causes economic contraction – Getting government debt under control — a must at some point, but does create short-term GDP pressure and does not address private debt levels – Growth or Inflation – takes 15 to 20 years — and bumps up against the dampening effect of debt on growth – Debt restructuring — obstacle of moral hazard and objections regarding wealth transfer — but a trillion in restructuring is better than a trillion in new stimulus – Live with it — don’t we always?

Questions and Provocations • Global leverage is increasing unabated – how and when will that trend end? • In the context of perpetually increasing leverage, all bank lending criteria is perpetually becoming obsolete • Global GDP growth has been decelerating in the last few decades — what will cause that trend to reverse? • How can we delever without contracting GDP?

Thank you, and stay tuned ‌..

• Richard Vague can be reached at rvague@gmail.com • Steve Clemons can be reached at sclemons@theatlantic.com • The data can be reviewed at www.debt-economics.org