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Tackling the Ongoing Problem of Too Much Debt


A certain amount of debt can help an economy grow. But there's a point at which too much of it becomes harmful.


Debt has been compared to a double-edged sword. A certain amount is constructive. But once you reach a certain threshold, a tipping point if you will, debt is no longer helpful; it's harmful. Kind of like bacon. Yes, bacon makes everything tastes better and it may seem like you can never get enough. But everybody knows if you're eating a pound or two at a time, you better keep the crash cards charged and close by. You're going to need them.

We've seen the effects of debt this year all around us. In fact, if I were going to vote for a Person of the Year, I would vote for debtors everywhere. From sovereign nations dancing on the knife's edge with default to Occupy Wall Street protestors calling for the expungement of debt, the effects of debt's vise-like grip was all around us this year. Debt matters, and dealing with this issue is not over. In fact, I would argue we have not made as much progress in dealing with the debt hangover as many would like to think.

Why does it matter? It's simple. Debt has fueled our economy for several decades now.

The question is, has debt provided too much fuel? Has it given our economy a sugar rush as a cheap substitute for an economy that runs on the leaner, more efficient, protein and antioxidant-rich fuels of savings and investment? Dietary analogies aside, this is an important question to frame and answer because doing so will determine the solution to the quagmire we still find ourselves in.

I actually started thinking about this a lot more when Kevin Depew shared an email with me not too long ago. In it was a reference to a paper from the Bank of International Settlements, "The real effects of debt" by Cecchetti, Mohanty and Zampolli. The paper examined data from 18 OECD countries between 1980 and 2010. They looked at debt's impact to economic growth and tried to estimate levels of debt that would be considered excessive and harmful to an economy.

But first, a high-level overview of the data. This first chart shows that the authors were able to segment data into three sectors: household, non-financial corporate, and government. While the Fed's Flow of Funds data does this and has a rich time series, not all countries treat this data the same way. At any rate, the chart shows that three decades ago, the total stock of debt for the three sectors was 167% of GDP. Now, it is 314%.

That translates into an annual growth rate in excess of 5% per year, which is roughly the same GDP growth rate the US has seen over the same period of time. But also, note who has been doing the borrowing; it hasn't been governments, but households and corporates. Governments have been relatively thrifty.

This next table looks at some of the countries included in the data the paper was based on. Note the debt levels of Germany and Greece. They're surprisingly close:

But, OK. Debt has ballooned in all of these countries over the past 30 years. What does that mean for GDP growth? Funny you should ask because the next table delves into that topic. It turns out debt has a negative impact on annual GDP per capita growth:

Government debt is shown to have a positive correlation with annual GDP per capita growth, but let's review the first chart: Government debt showed the lowest amount of growth over the past three decades, despite the political wrangling you and I hear day in and day out about it. The Bible verse of taking out the plank in your own eye before removing the speck from the eye of your neighbor comes to mind.

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