Weekend Chart To Ponder - Macro Economics

I have been challenged repeatedly on the chart of credit and population that I put forward; for those who want to review it, here it is:

The argument is that (1) there is no axis (although its relative graph so I find that argument rather lacking) and (2) it is not adjusted for "inflation."

The latter is troubling.  See, what inflation number do you use if you want to measure stress on the consumer?  After all, the point of the chart is to measure consumer debt load and stress, right?  I think so.

So on went my thinking cap and after a bit the light went on - the measurement of stress would be best defined by per-capita income compared to per-capita consumer debt.

This excludes, of course, government debt, which has been rising at an astronomical rate as well, but the impact of that rise can be delayed, because (at least so far) we can borrow instead of tax.

Anyway, the modified graph is here, and it revealed some very interesting things.

The last two lines are per-capita - both income and credit.  Gross credit in the system is taken from the credit number, and per-capita credit is simply credit out divided by population.  Since none of these are inflation adjusted - that is, they're all in raw dollars - the income and per-cap credit numbers provide an excellent relationship measurement between income and credit outstanding.

Notice that through roughly 1993 credit growth per-capita roughly correlated with income growth per-capita.  That is, while credit growth expanded pretty dramatically, so did per-capita income.  The early 1990s recession actually brought debt levels down and they corrected to a normed level - coinciding with the end of the recession!

But starting in 1993 this behavior changed.  That is, the level of stress imposed by increasing credit - Americans living beyond their means and pulling forward their income with credit (ab)use - accelerated and never looked back.

Worse, from 2001 onward the gap has exploded as the government's policies to "go out and shop", coupled with insanely low interest rates, made pulling forward demand an American pastime.

With the recession of 2000-01 instead of allowing the economic forces to drive credit down (or hold it constant until per-capita income caught up) government and Federal Reserve polices encouraged even more pulled-forward earnings power and consumption, placing us on the path to ruin.

Note too that these credit numbers do not reflect mortgages - at all.  I don't have a clean data series for those that's immediately obvious or I'd add it (if someone has one, drop me a link to a referenced Excel file and I'll add it) and I suspect that would make the chart look really ugly.  I also don't have per-capita income numbers from the Census for 2008 as of yet, so that series is missing the last value - but the ominous change in 2007, where income flattened while credit outstanding continued to soar - is apparent.  This graph also does not include the impact of increased government debt, yet it is invalid to ignore that, since eventually government borrowing must be paid back via higher taxes.

So in fact the situation for the American consumer is significantly worse than depicted here.

But this is a fairly clean representation, however, of the "pulled forward" demand that we have shoved into the economy since 1993 through ridiculously-loose consumer credit.

I have often been asked what it would take to bring the consumer credit picture back into balance with incomes.  My "off the cuff" estimate was that we had to take a 10% adjustment to GDP in 2000, a 20% adjustment now, and that credit would have had to contract by about 20% in 2000.

This graph makes it clear - as of 2006 the answer is "roughly a 40% decrease in credit outstanding, a 40% increase in per-capita income, or any combination of the two."

Of note the "correction" required was 25% in 2000. 

It was 40% in 2007. 

It is likely better than 50% now.

Not bad for my "back of the envelope" computations when one puts hard numbers to the question, eh?

This graph, more than any other, illustrates the folly of "kick the can" when it comes to recessions.  We are in this recession and facing an economic depression due to consumers "hitting the wall" - the spread between per-capita income and per-capita debt became impossible to service, and the defaults started to snowball.

To fix our economy consumer incomes must be brought back in line with per-capita debt - period.

There is no path out of this mess that involves taking on more debt, as is clear from the above, as doing so will simply cause the divergence between income and debt to widen further.

Wake up America.