The Illusion of the Bush Economy's Growth is Revealed

Ever since I have been writing about the economy (about 4 years) I have focused on the mammoth increase in US debt during this expansion. It has led me to question the underlying vitality of this expansion as a whole. Events of the last six months indicate the markets are also asking the same question right now, although in a somewhat different way.

In effect, the economic dominoes are starting to fall. Ultra-low interest rates which inflated asset prices and allowed an explosion of debt are starting to seriously bite as a financial system is burdened with too much bad debt on its books. In addition, the market is starting to realize that asset prices -- namely housing -- were ephemeral and will have to drop. In effect, the entire economy is going through a process of reevaluating "the greatest story never told" and are discovering it wasn't that good a deal to begin with.

Let's start with a few basic charts.

Above is a chart from of total household debt. Notice the curve is almost parabolic over the last few years -- and especially this expansion.

Above is a 10 year chart of household debt. Notice it has increased from about $8 trillion to a little under $14 trillion, which is a really big increase.

As a result of this increase in total household debt outstanding, the householed debt payment ratio has increased to the highest level in 25 years.

Let's place the household debt level in perspective. Here is a chart tabulated every 5 years of total household debt outstanding and its percentage of GDP and total disposable income. The GDP and disposable income numbers are from the Bureau of Economic Analysis and the household debt numbers are from the Federal Reserve's Flow of Funds Report. The figures for 2007 are for the third quarter.

Notice that both percentages jumped sharply during this expansion. This is what easy credit will do for you.

Now -- this massive debt orgy has allowed the US to inflate its home prices.

This has allowed Americans to extract home equity loans from their homes to buy more stuff. Because home prices increased so much in value, Americans felt richer, so they felt as though they could spend more.

Now, I'm not alone in questioning this expansion. Business Week has an article titled, How Real Was the Prosperity?" where they ask the same question.

Consumer Spending: The rule for a prudent individual is simple: Don't spend more than you make. For a long time, the U.S. economy obeyed that rule. As far back as the 1960s, personal spending, adjusted for inflation, has basically tracked the overall growth of the economy, as measured by gross domestic product. Sometimes consumers would get ahead of the economy for a few years, and sometimes fall behind, but never for very long.

That pattern changed in the 1990s. As of the third quarter of 2007, the 10-year growth rate for consumption was 3.6%, vs. GDP growth for the same period of 2.9%. This difference represents an enormous gap. If consumer spending had tracked the overall economy over the past decade as it has in the past, Americans today would be spending about $600 billion less a year. The extra spending has amounted to a total of about $3 trillion since 2001.

Consumer Lending. The past 10 years will go down as one of the greatest consumer-lending sprees ever. Adjusted for inflation, consumer debt--including mortgages--rose an average 7.5% per year since 1997, far faster than the 4.2% rate of the previous 10 years. The last time debt rose so fast was the 1960s, as the postwar generation bought homes and autos. If Americans had kept borrowing at their pre-1997 pace, they would have had about $3 trillion less in debt.

Corporate Earnings. Yes, there's been a profit boom in recent years. Corporate earnings, as measured by government statisticians, have averaged 8% of GDP over the past decade, up from a low of 6.5% in the early '90s. That has helped propel stocks upward.

But here's an unfortunate truth--the profit surge has been mainly in one area, financial services. Financial institutions have benefited from the consumer credit boom, the proliferation of new financial instruments, and relatively low rates. By contrast, the earnings of nonfinancial companies over the past decade have averaged about 5.3% of GDP, about the same since the mid-1980s. There are few signs of any acceleration, even after years of restructuring.

Right now we're just starting to deal with the hangover from this debt orgy. The entire financial sector has been wracked by writedowns for the last 6 months. No one has been spared. Estimates are for total writedowns of $300-$500 billion. So far, we've only had $100 billion or so, so we have a ways to go.

We just had the weakest holiday season of the last 5 years, indicating consumers are starting to get tapped out -- they can literally borrow no more. While it is never a good idea to bet against the American consumer who will sell his mother to buy the next thing, high gas and food prices, a tanking housing and stock market and a weakening job market will undoubtedly provide some serious headwinds for the foreseeable future.

Consumer lending is going through the wringer right now as well -- and for good reason. It use to be that all you needed to get a loan was a pulse. Now you actually have to have a credit score.

But the central problem of this expansion is all of that debt has to go somewhere. You can't just slice and dice a pool of debt into many pieces and completely eliminate risk; that just can't be done. But everyone thought you could do it, which is basically how we got into this mess in the first place. Now everyone has the pleasure of choking on a ton of bad loans. And it's not going to stop anytime soon.

To make matters worse, the level of debt in the economy assumes a certain asset value. For example, if a banker makes a $100,000 loan for a $100,000 house and the home starts to decrease in value, the banker will at some time have to writedown the value of the loan. So as home prices decrease anyone who owns mortgage related debt (and that is literally everyone on the planet) will have to writedown the value of their debt. This constrains their ability to make new loans, which hurts an economy like the US which depends on credit creation.

That's the central point to the Business Week article's title. This expansion is based on the inflation of an asset class -- namely, housing. As that asset increased in value, consumers felt wealthier and therefore spent more. They extracted more equity from their homes for more consumer purchases. This was a net positive for consumer spending and the economy as a whole. However, as that asset value decreases -- which is what we are experiencing now -- the exact opposite is also true. Consumers will spend less because they feel less wealthy. And they probably will for some time.

Comments

[cynara]

You know that line "But the central problem of this expansion is all of that debt has to go somewhere", got me thinking.

This whole "debt bubble" is looking scarily like the dot-com bubble or the housing bubble. There is no money being exchanged. People are going buying on credit on speculations of future earnings, just like people bought stocks during the dot com bust on companies with no cash inflow, or people buying houses with no money down, hoping they could flip them for more money before they had to make a single payment. In all of the above cases, there is no cash basis for the transactions, which is why they ultimately fail.

Which makes me worry for our economy. Speculation lead to the great depression, we could be speculating ourselves into oblivion again. The Household Debt charts were painful to look at...

[hchriste]

Maybe the economy is bad because we spend 10 million a day or Iraq with no return on the investment. Giving a rebate to taxpayers is just a transfer of wealth from the goverment to corporations, the taxpayer is just the middle man. Why not cut back the spending in Iraq, spend the money repairing the bridges and highways that are falling apart. putting more people back to work with real jobs and real money which will spur the housing market again.

[Zaro]

We have just reached the limits of capitalism, that's all.

[mmckinl]

"This expansion is based on the inflation of an asset class -- namely, housing. " Bonddad

And now comes the contraction; Why ?

Not only because feel less wealthy, more importantly because banks won't have money to lend except to sterling credit at elevated rates.

It is called 'debt based fractional banking' run by the privately owned and operated Federal Reserve ...

Where are the editorials and columns about the role of debt-based currency and the viability of a privately owned and operated Federal Reserve?

The Panic of 2008 is all about debt-based currency and the role of the Federal Reserve in (not) regulating the financial system.

Who will ask the tough but necessary questions: Why shouldn't we fire the Fed? and, What is the role of debt-based money in the rapacious destruction of our environment?

The Libertarian Right have their position on these matters; Where are the Progressives and Liberals ?

[Ron]

Bonddad, the real truth is and has always been this smoke and mirrors administration has lied and falsified information to the american people to promote their policies and agenda's. Like the previous Bush voodoo economics, or trickle down economics, this bush and cohorts have figured out how to finance their elections and line their pockets with money from phoney wars, and drain the treasury and misuse and abuse their powers to promote corporate welfare. Now that the dollars falling, the markets are falling, and its election year, they're struggling a way to blame the Dems for the trouble they are in. He's lied and misled people all his life, and remember "Elbusto", where he illegally dumped all his stock before the company went into the dumper. Its just more of the same from a failed president, and his failed economic policies that rewards the rich, and people who break the rules and expect to get away with it. Just like the present canidates who are bush lackeys, and will only promote more of the same, where everyone but the rich will have to suffer. Liars, and a very good con job used on the american people.

[thegulliblecitizen]

And we have stimulated the Iraqi economy so long that now we must stimulate our own so we can keep stimulating the Iraqi economy that we now own. We will continue to play the Iraq casino as long as our prophets are all socks and our profits are not schlocked.

[Mormondude]

In your very last post, you asserted that money was EASY to get. Now you're saying that money is HARD to get, because writedowns prevent banks from lending as much money. Your main point was that since money is easy to get, making money cheaper isn't going to help anything. It sounds like you're contradicting yourself.

The way you describe it, writedowns aren't actual losses. It's kind of like how if you buy a stock today and it drops tomorrow, you never actually lost money. You only lose money when you actually sell the stock for a lower price than you paid. The only way for banks to actually LOSE money is for them to foreclose on the house and have to eat the difference between what they paid for it and what they can sell it for.

So, whether or not the banks writedown the value of their assets doesn't directly reflect their profit or loss. Only their ability to loan in the future.

For example, if someone bought a new house for $500k and now it's only worth $400k, the bank still makes the exact same amount of profit on the loan if the person actually makes their payments, because the terms of the loan don't suddenly change.

[MadAppraiser]

How can American citizens trust any overnight Washington, D.C. corporate bailout program after this unprecedented, and unregulated American corporate free for all??? In an environment of unregulated Iraqi War debt, private banking/Wall Street institutional greed, United States trade deficit, corporate employment outsourcing, and federal government private contract profiteering, how can American citizens trust any new economic policies from these eloquent, disoriented political leaders???

[WIpatriot]

Bonddad, you are, as the kids these days say, a "rockstar." Always on the mark with your posts.

[OhgReaTone]

Romney and Huckabee - Mormon and Baptist - Religion and money - are these terms mutually exclusive?
Ohg
http://thefiresidepost.com/2008/01/26/make-money-for-christs-sake/

[rabun666]

Ronald Reagoon started the debt explosion by convincing Americans that debt is prosperity, and he was and is believed to this day. The $3,000,000,000,000 less debt that would have incurred had spending kept at the pre 1997 levels which corresponds with Clinton's budget "surplus" and Bush's$3,0­00,000,000­,000+ deficits. Their may be a correlation here. Debt is appealing because it has been seemingly painless until it comes due.If something can't last forever, it won't.

[NicoleAnonymous]

Is there any truth to the rumour that Bernake was influenced to make the rate cut this week based on the billions lost by that French trader?

[rlc41]

What in the world have I been doing? I have a modest home that is right sized for me and has been "payed for" for years. I have a 1999 car bought used, has low mileage, well maintained and in great condition and it has been "payed for" for years. I don't have rooms and piles and piles of the latest and greatest gadgets. I have no credit card debt. I do have savings and now the value of that is going to tank because of all the idiots that can't see past the end of their noses? Guess I'm in that group too thinking that debt free living was the way to go.

[bertisbert]

Bonddad:
Excellent, as always. Your best attempt yet at clearly depicting the reality of the impending depression that will undoubtedly result from this debt-induced spending spree the past 10 years. I remember reading a few years back about Alan Greenspan's economic theories and what, at the time, seemed like a bulletproof philosophy. That was the idea that as long as housing values continued to rise, there was no such thing as "bad debt". Maintaining mind-bogglingly low interest rates for as long as he did to prop up this facade never made any sense to me. But, when I saw the fact that more and more people were buying homes at their incredibly inflated prices, I suspected that maybe I was somehow missing out. Then I read the fine print. This bubble was SO obvious, and the fraud being perpetrated was so blatant. Look at the winners and losers here, and if you still can't see that somebody as smart as Greenspan must have had some complicity, well, then I guess you probably still believe Ken Lay died an innocent man.
So, here we are, waiting for the other shoe to drop. In my part of the world, that means waiting for that $700,000 starter home to come back down to it's true value of about $450,000. Still shaking out a lot of those "brokers" and "lenders" that actually saved some of their ill-gotten means. It's OK. There will be another "get rich quick" scheme coming along soon!
Happy hunting...

[Herrington]

This is amusing, or would be if the rest of us were not caught in the down draft. In fact, if not in principle, the Bush tax cuts were intended to help the rich get richer. As regards any purported goal of stimulating the economy, tax cuts have never, repeat never, stimulated the economy.

So tax cut windfalls in hand, the rich are now being taxed by the collapse of their hedged portfolios, a dollar in free fall, three dollar gas and the shrinking value of their mega homes. It might have been better even for them to keep their tax rates as they were. Their taxes could have helped stave off the current economic crisis by spreading the money around. As it is, their tax savings will evaporate and we will all have suffered from the imbalances.