US Consumption Growth and US Debt -- Magnitudes and Relationships

In an earlier posting, I said that the main US consumption growth inhibitors would probably be American debt, and the rising price of natural resources, particularly oil.

This post is my first in a planned series in which I take a detailed look at the debt situation in America and the world.  This first post looks at total US debt and compares it with US GDP growth over long time periods.

  Figure 1.  World Real Average Compound Annual Growth Rates (CAGR) for Population, GDP/Capita and GDP.  History from deLong and US Census Bureau, Projection from ERS, USDA.  History is based on "1990 International Dollar", projection is based on Real $2005. 
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I compiled Figure 1 to remind myself of recent world growth history, and the consensus projection of where we think we are going.  The projected GDP CAGR of approximately 3% implies a doubling of GDP in just under a quarter of a century.  In other words a doubling every generation.  Clearly, if these numbers are to be believed, and if we think we are going to do something about climate change, we certainly do not plan to do it it by intentionally reducing consumption.  

In fact, Figure 2 below, which focuses on more recent and "narrower" history, illustrates that we are planning to increase both the world consumption growth rate, and the consumption growth rate of the United States, which itself is approximately one quarter of world consumption.  Figure 2 also implies we plan to do something different than we have been doing for the last four decades, since our consumption growth rate has been slowly falling during that time.

 Figure 2.  World and US GDP Average Compound Annual Growth Rates per decade based on Real $2005.  History and  Projection from ERS, USDA.
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To give us a sense of our actual and planned consumption, measured in dollars, Figure 3 below places dollar numbers on the percentage growth rates shown in Figures 2 and 3.  As we see, we are planning on a $100 Trillion world GDP (twice today's consumption), and a $22 Trillion US GDP (about one and a half times today's consumption) within two decades.

 Figure 3.  World and US GDP Actual and Forecast in Real $2005  History and  Projection from ERS, USDA, IMF, World Bank

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How realistic are these growth projections?   My interpretation of the data I have collected says, that without continued and massive government fiscal interventions, the level of planned growth is very unlikely to occur.

The data I will present in this and later posts tells me, among other things, that::

• World consumption growth in recent decades has been driven primarily by American consumers, spending borrowed money, created out of thin air, by the American FIRE sector (Financial, Insurance, Real Estate).
• This amount of "credit creation", and the consequent debt incurred by American consumers, measured in money, and as a ratio to GDP, is much larger than any period in American history,  including the worst periods of the 1930s depression and World War II.  
• The recent decade's transfer of wealth, and income growth, from middle class Americans to wealthy Americans has left middle class Americans deeply in debt to wealthy Americans.
• The indebtedness of middle class Americans, the (former) engine of world consumption growth, has now run out of fuel.  Middle class Americans cannot incur any more debt, and there is little sign that their income or wealth will increase in the near future (the next decade) which would need to happen for them to take on more debt.
• Therefore, either the planned continued consumption growth must come from the injection of money into the economic system by the US (and other) governments, or the planned world and US consumption growth rate must fall.  
• The explosion of world debt and consumption in the industrial nations during the last few decades is now forcing the world, and in particular Americans, to make critical choices about their countries investments.  
• It is not "whether" governments will print money and and invest in the future.  It is "how much" they must print, and in what projects they must invest.  The invisible hand has been shown to be a bloody claw.

Let's begin our debt discussion by examining the historical "debt to GDP" ratio in America during the last five decades.

Fig 4 below, showing "Total US Credit Market Debt" and "GDP growth" is the first of many charts on that relationship. The underlying data comes from the  Federal Flow of Funds Report.  The chart itself comes from Contrary Investor.  Later in this and other posts I will deconstruct "Credit Market Debt" in gory detail.  Please accept for now that "Total Credit Market Debt" is a reasonable representation of the total indebtedness of Americans to each other and to the rest of the world.  Note the relatively stable relationship of debt to GDP in the 1960s and 1970's and in the early 1990s.  

Figure 4.  US Credit Market Debt and GDP Growth from 1962 through 2009.  Chart from Contrary Investor
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"US Credit Market Debt", by sector, is published quarterly in the Federal Flow of Funds Report, an official publication of the US "Fed".  Figure 5, based on the data in that report, shows GDP, total US debt, and US debt of various sectors.   As you see, according to the Fed Flow of Funds report, total US credit market debt at the end of 2009 totaled about $52 Trillion, with domestic non financial debt at about $34 Trillion,  domestic financial debt at about $16 Trillion and nominal GDP at about $14 Trillion.  The ratio of 52/14 is approximately 3.75, which is where the 375% number in Fig 4 comes from.  I have intentionally shown the projection of GDP through 2015 for a reason which will become clear in later posts.

Figure 5.  US Credit Market Debt by sector in Billions of $2005  Fed Flow of Funds March 2010
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Let's take Figure 5 apart.  It says that:

• Current (2009) "Total Debt" is about $52 Trillion.  Is that a "lot" or a "little"?  Certainly compared with the last four decades it is a hell of a lot.   It also turns out, compared with GDP, it is enormous by any standard, including the Great depression and WWII.  Is it "too much"?  No one knows -- this is uncharted territory.  How does it compare with other countries?  Looks much the same (and worse) in the UK and Japan, and several other industrial countries.  Looks different (and better) in Chindia.  I will cover that in later posts.
• If I look closely, I see that something called "Domestic Non Financial Debt" (which includes all Government Debt) is the largest single element of total debt, measuring about $34 Trillion. 
• Next comes the "Domestic Financial" debt (the green line) at about $16 Trillion;  note the sharp down turn in 2009, as bank debt begins being written off and transferred to the government.  
• And last comes a tiny "Foreign Debt" element at about $2 Trillion. 
• So 34+16+2=52.  Of the "$34 Trillion Domestic Non Financial Debt", "Government Debt" is about $10 Trillion.  About $2 Trillion of this $10 Trillion is "State and Municipal Debt" leaving about $8 Trillion of "Federal Debt".  This is the  "Federal Government Debt" which the media and some economists yell very loudly about.  This $8 Trillion number increased rapidly in 2009, and will skyrocket in the next two years as the bank bailouts reduce the (apparent) debt of the financial sector and transfer it to the Federal Government.

Figure 5 specifically notes that it is a picture of "Debt Recorded on Bank Books".  Why this disclaimer?  Because:

In the last three decades politicians have helped bankers, lawyers and accountants to "game" the financial, accounting and legal system.  They have devised myriads of ways to hide debt to make balance sheets appear healthier than they really are.  No one, and I repeat no one, in any country of the world, now has an accurate idea of the debts their countrymen have racked up, either to each other or to foreigners.  In the case of the US, total debt is certainly greater than three and a half times GDP.  I plan to make the reasons for the opacity of world and US debt a little more understandable as I continue blogging.  Here is a quick synopsis of the situation to start the explanation:

• America had developed an accounting system (NIPA) shortly after the 1930s depression which worked pretty well through World War 2, and through the boom years of the 1950s and 1960s and the early 1970s.  With the scandals of the 1930s fresh in the minds of the NIPA system developers and the strong "anti bank" Roosevelt administration, "investment banks" and "commercial banks" were walled off from each other.  This NIPA system, or facsimiles thereof, is used today throughout the world.  The Fed Flow of Funds report which I use for debt reporting, uses the NIPA system.  
• This NIPA system of reporting began (slowly and unintentionally) being corrupted in the 1980s as a result primarily, of Nixon (in the early 1970's) unilaterally abandoning the Bretton Woods "Gold Standard".  Nixon had little choice.  He was stuck with a promise that America would purchase dollars at $35/oz of gold from countries which wished to exchange their excess dollars for gold.  US gold reserves were pouring out of Fort Knox to pay foreign countries for Vietnam War supplies, and America was rapidly running out of "money" ie gold.
• With the abandonment of a "natural resource" standard, (which used to be gold) the US dollar became the world's reserve currency (gold supply), and any real limitations on the amount of "money" available due to the scarcity of gold disappeared.  (Gold is a relatively scarce natural resource, and as long as a fixed quantity of gold could be demanded for each dollar in circulation, the amount of dollars in circulation was necessarily limited).   
• Fortunately for us Americans, the printing presses which created dollars were locked up in Washington, and Americans (and only Americans) had access to them.  Americans could therefore create as much "gold" (money) as the President (and Congress) desired.  Thus was the most recent episode of "fiat money" born.  Every other currency and world resource became tied to the American dollar.  World currencies still are, although the Euro is now a possible contender for some portion of the world money standard.
• The 1970's brought the abandonment of the gold standard (Nixon), the peaking of American oil production, and the oil embargo.  The 1980's, brought an increase in American oil imports, and a surge in American rearmament ("deficits don't matter" Reagan), and the fall of the Soviet system.  The result of all these events was the beginning of a river of dollars leaving America and ending up in the coffers of America's suppliers, as Americans became the "spenders of last resort".  Since then, due to the appetite of American consumers and American wars, that river has become a deluge.
• These vast quantities of American dollars (the new gold substitute) started sloshing around the world particularly in the coffers of sheikhs, shahs, dictators, arms merchants and other exporters of goods and services to America.  These dollars provided the source material for revolution -- Iraq-Iran war, Mujaheddin, Iran Contra, El Salvador... -- and world wide corruption.   Their presence in the (US and other) bank accounts of individuals and "sovereign funds" created huge pressures on bankers and politicians for investment vehicles for these funds.  Eventually, the demands for "creative" accounting and new "investment vehicles", proved too much for politicians looking for election money and retirement jobs, and for banks looking for unfettered access to the wealth of individuals and in the ultimate, "The Wealth of Nations" ie "Sovereign Funds" -- think Iceland, Greece, Ireland....  
• It was during the 1990s, with a Republican legislature, an "Ayn Rand" Fed Chairman, and a Democratic (and sympathetic) President and Cabinet (Clinton, Summers, Rubin) that the last walls separating commercial banking concepts from investment banking concepts collapsed.  It was also the end of classic "fractional reserve banking" where certain reserves (about 8%) had to be maintained and where the practices of investment bankers with their risky bets were clearly separated from the age old traditions of boring old commercial bankers.  American "shadow banking" had begun, and in the first decade of the 21st century, it permeated the world. 
• By the end of the 20th century, after the dot com bust, with Alan Greenspan's near 0% real interest, credit (and therefore debt) exploded.  New "financially engineered" products appeared and were sold to unsuspecting pensions funds all over the world.  Most of these credit vehicles had no "reserve requirement".   Hundreds of trillions of dollars in "insurance like" investment vehicles were hurtling around the world, bankers were taking home hundreds of millions of dollars in compensation every year, and hedge fund managers became billionaires.  The rich became richer and the middle class got squeezed.
• "Money" is now a "mushy" concept.  Money is created every time a bank makes a loan to a customer.  "Bank Reserves" do not limit the amount of the loan.  "Money" in its current incarnation, is created if a banker, any banker, thinks he can make a profit by finding a customer and funding a loan.  That loan can be removed from the banks balance sheet, (almost) eliminating bank risk, leaving room for more loans.  Thus the pressure on bankers to hire salesman to find loan customers became enormous, and the idea that a debtor should have the ability to honor his debts became quaint.
• So... among the infinite number of financial instruments (loans) now extant, how much of the roughly $600 Trillion in derivatives, not on the books, (10 times the world GDP!) is "money"?  And how much debt is tied up in "off the books vehicles" like SIV's (think Enron, Lehman, Stanford)?  I certainly don't know, and I have seen no satisfactory answer to that question.  The experts all differ, and their differences appear to be related to their own self interest in the answer to the question.  Hence my statement that nobody accurately knows the extent of American (or any other country's debt).
• The "uncertainty" about the amount of debt in America resides primarily in the "Domestic Financial sector" as reported in the Flow of Funds report.  This sector is reported to be $16 Trillion at the end of 2009.  It is unlikely that there is more than about $4-5 Trillion more (~25-30%) hidden in various "off balance sheet" schemes and bad debts.  So it is probably reasonable to use the Flow of Funds report and to assume that the financial sector is understated, and that the total debt is $55-58 Trillion, when assessing total US debt.  
• So I will wrap up this brief review by summarizing:  The Flow of Funds report I use for this series is a genuine, balanced and honest document prepared by honest people doing their jobs.  It is not a complete story about American debt, but (and this is a guess) I don't think it is off by more than about 10% or about $5 Trillion in the total reported $52 Trillion.   In future posts I will be analyzing various of the reported debt sectors in detail.  Paradoxically, it turns out that adding "Financial Debt" to "Non Financial Debt" to come up with "Total Debt" actually double counts certain investment vehicles, assuming everything on the books was indeed accurately recorded, and there were no "off book" shenanigans.  Because everyone knows that the $52 Trillion is probably understated, most of us add the financial and non financial together to come up with a "total".  Is it likely to be off by more than $5 Trillion?  I don't think so, but I have no data to back up that assertion.  In any case, the non financial debt by itself is hugely much larger than it has ever been.

I will end this post by presenting three charts on total debt and one on "non financial"debt as debt is related to GDP. Between them these charts cover the time period from the 1920s to 2009 for the US, and several countries in the 1990s.   The first one is figure 7 from a paper by Professors Reinhart and Rogoff, the leading authorities on the history of debt and its consequences.  The second is from a lengthy report on debt by McKinsey Global.Institute on the state of indebtedness of various countries.  The third one is a chart from the well known financial adviser Ned Davis and the fourth one is about non financial debt, also by Ned Davis. 

---Professors Reinhart and Rogoff  Growth in a Time of Debt
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From McKinsey Global Institute "Debt and Deleveraging"

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Fr

--------From Ned Davis via Cluster Stock----

From Ned Davis via Cluster Stock

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