Increased debt levels are responsible for the GDP growth we’ve seen since 2009 and the people least able to afford it are financing our country’s growth with debt
While economists, policymakers and the media tout the U.S. economy’s stellar economic growth since we came out of the great recession in mid-2009, a simple, harrowing truth paints a much less rosy picture: our growth is not being fueled by better jobs, better wages, or more prosperous lives for the average American. It’s being fueled by massive, historically-high debt levels that will eventually cripple the people who are least capable of handling it.
If you follow business news even sporadically, you are probably aware that we are in the midst of the second-longest economic expansion in the U.S. since before the Civil War (more than 150 years ago). In June of this year, our economic expansion celebrated its 9th birthday. But a closer look at the data suggests that celebration is probably not the most appropriate reaction. The reality is that this economic expansion has been almost entirely fueled by debt – consumer debt, corporate debt and government debt. And it is going to be consumers who bear the brunt of it when the expansion ends.
As a result of the great recession, U.S. Nominal GDP fell to $14.4 trillion in 2009, and since that time has risen to $19.4 trillion in 2017. That is a $5 trillion increase in annual GDP in an 8-year period, which certainly seems like an impressive number. But look what has happened to debt levels in our country over the same time period. Consumer debt has risen by $1 trillion since 2009, from $12.1 trillion to $13.1 trillion. At the same time, debt has ballooned on corporate balance sheets from $3.7 trillion to $6.1 trillion, an increase of $2.4 trillion. And last but not least, government debt has increased from $11.9 trillion to $20.2 trillion, a staggering increase of $8.3 trillion. Add that all up and you have an increase in total debt of $11.7 trillion in exchange for GDP growth of $5 trillion. Does anyone really think that is a good, sustainable trade off? What would the response be to a company that asked to borrow $11.7 million in order to fund revenue growth of $5 million? Even the nicest banker on Wall Street would politely end the meeting as quickly as possible, “Thanks for coming in…”
In fact, consumer debt is up by a full $1.8 trillion since it bottomed out in 2012. And it is currently half a trillion higher than the prior peak before the great recession. Does anyone remember in the wake of the 2008 crash how much attention and blame was placed on debt levels – how many journalists and politicians told us (after the fact) that it was inevitable and obvious that the game would end badly. Bubbles are always obvious – from tulip bulbs to dotcoms – after they have burst.
On the consumer side, increases in debt levels are being fueled by more and more “technology” companies jumping into the consumer lending business. That includes many here in Silicon Valley who think that simply being from Silicon Valley makes them better than companies that have been honing their credit risk and underwriting models (and learning from painful experience) for decades or centuries. It seems like a great mix at first – a Silicon Valley data and technology mindset to a staid old industry – a match made in heaven, right? The rub is that the drive for growth at all costs, mixed with credit risk and lending, is a match made in hell. The two are almost diametrically opposed. It is very easy to grow a lending business – “Here is some money, do you want it?” On the flip side, it is very easy to control credit risk “No money for you! (or anyone else).” Doing both – growing a lending business while controlling credit risk – is a real challenge – one that takes a combination of people, processes, technology, analytics and humility in order to succeed. In a typical venture backed company, the drive for growth trumps everything. And that mindset often makes sense – by growing at all costs, you are risking only two things – the time and opportunity cost of the founding team and the equity investment from the venture capitalists. That is a smart and fair trade. Whether it implodes or takes off, the founders’ and VCs’ losses or gains are commensurate with the risks they took. So put the pedal to the metal and see what happens. When you bring in lending, balance sheets, and credit risk, the game – and the associated risks – are completely different. The repercussions of an implosion expand dramatically to lenders and their counterparties, and to over-leveraged consumers stuck with loans they can’t afford to pay back.
Predicting the end of an economic expansion is nearly impossible. The only thing that we say with certainty is that this economic expansion will end at some point. And unfortunately, it is going to be consumers who bear the brunt of the pain when that happens. It is not going to be possible for consumers, governments and corporations to expand their balance sheets in the way they have over the past 9 years to get us through the next recession. Debt levels are too high to double down. This leads to some combination of the following outcomes: layoffs at corporations trying to right size their cost structure and service their debt loads, a fiscal contraction (with lower wages, lower employment), and/or inflation fueled by monetary expansion as the government prints money in order to service its debts, resulting in lower real wages. Each of these outcomes results in consumers feeling the brunt of the pain as lower employment and lower real wages come face-to-face with massive debt burdens.
Household savings rates are paltry, few Americans have emergency funds to cover any unexpected expense, and – as Deutsche Bank says – “balance sheets have become more fragile for the lower part of the income distribution.” Real wages for mid-range workers have not risen, despite promises that corporate tax cuts would deliver a windfall for the American worker. And prices for everyday goods continue to rise.
On a macroeconomic level, when the proverbial music stops, not only will millions of Americans find themselves under water, but also the options available to the government to help soften the landing will be greatly reduced.
Well I am sure that was a fun read, so what can an individual consumer do about it? While it’s not always possible to live within our means, the pace at which we have been spending – as individuals and as a country – is unsustainable. It will behoove us all to think more like those trusty, old-school credit risk modelers and less like Silicon Valley VCs. In my next post, I’ll talk about ways that consumers can help prepare themselves for economic uncertainty.