Sunday, February 15, 2009
Where are we going, and what lies next? To address these questions, we need to know how we got here in the first place.
I want to share with you an interesting observation that I think will provide great clarity and insight into our current predicament, as well as indicate that our recovery, such as it is, will be protracted and incomplete.
It begins with our old friend, the Debt-to-GDP chart (below), with our long-term average circled in green and our recent debt experiment in red. Today we’re going to focus on what happened there in the 1980s, when we began our long climb to our current levels of over-indebtedness.
Now, this is not a partisan statement by any means, because both parties played along, but Ronald Reagan’s terms in office (1981-1989) are marked by the blue box. It was during his tenure that we initially began our experiment with ever-larger piles of debt. Somewhere in the early 1980s, we clearly broke out of a long-established normal range of debt and into new territory. Something happened there, but what?
Before I explain, let’s make a few additional observations. What else was in play in the same timeframe that debt was exploding?
First, we must remember the US personal savings rate, which, as noted in the Crash Course, was inversely correlated (to a very high degree) during the same timeframe. As debt was climbing, savings were falling in lockstep.
Note in the image above that the erosion in savings began sometime in the early 1980s, slumping inexorably towards zero the rest of the way. But I want to be careful here in how I associate the first chart (above, the Debt-to-GDP chart) with this chart of savings. Certainly, they appear highly correlated, but this is not the same as saying one is the cause of the other. Correlation is not causation, and we should always endeavor to be careful to distinguish the two. Still, there is a very tantalizing symmetry between the two that bears exploration.
If I were to speculate, I would guess that the erosion in personal savings was not tied directly to debt, but to a sense of wealth and well-being. The Fed has produced plenty of research papers investigating something called “the wealth effect,” which is the degree of additional consumer spending that can be estimated to occur as a direct consequence of rising asset prices.
by former_user