Expensive Misconception: Economic Growth was Fueled by Debt

Individual investors must watch out for the latest piece of nonsense from those preaching doom and gloom.

The statement is that the U.S. economic growth, particularly that of the last five years, has been artificially induced by debt.  The implication is that the economy will collapse like a house of cards when the debt must be repaid.  Those making these statements call this "incontrovertible fact", culminating with an issue of Time Magazine that will be the most expensive copy you every buy, if you read and believe this article.

At "A Dash" we have a key mission of helping individual investors.  Part of this work involves trying to develop some guidelines about how and where to find the right information.  We look for various sources on a topic and try to find the real expert.  Let us see how an astute individual investor might analyze this current proposition.

  • Look at people’s credentials!  When everyone is on one of those televised "debates" it may seem like they are all equal.  Sometimes those in the know are a bit less eloquent or glib than those who lack the relevant expertise.  This is especially true when the format emphasizes sound bites.  Our review of those focusing on debt-based growth is that they are usually non-economists–often journalists, bloggers, traders, or "global strategists".  They usually have a special agenda — promoting a book, or a web site, or their own trading positions.  Since they never did the formal work required to understand economics, they disparage those who have real expertise, claiming that it is irrelevant, or even a disadvantage!
  • See if the author knows the basics about the topic. With respect to debt, these writers choose to look at only half of the balance sheet.  They ignore assets!  Many of my smartest and wealthiest friends have elected to increase debt because of the attractiveness of various investments.  Corporate CFO’s learn to compare financing from debt and equity.  Is it surprising that in an era of low interest rates, many astute people have chosen to buy homes and to consolidate high-interest consumer debt into low-interest home equity loans?
  • Do a reality check.  Does the argument make sense?  Do we really believe that three years of double-digit growth in corporate earnings was achieved through stupid decisions by all of the leading corporate CFO’s?  Are the journalists and bloggers smarter and more knowledgeable than those running these businesses?
  • Compare the types of evidence.  Those making the debt argument paint a world where consumers are "spent up" and debt-laden.  They make anecdotal arguments about people who are the marginal borrowers, and act as if this is evidence of the mainstream.  They lack accurate quantitative analysis, often making outrageous projections using "black or white" estimates instead of using economic basics about supply and demand.

Considering the Facts

The household balance sheet is excellent, and has never been better.  David Malpass, an excellent economist with a great record, wrote as follows in December:

The multi-decade accumulation in U.S. household assets, not
reflected in the personal savings rate which excludes gains, is a key factor in the economy’s sturdiness and strong long-term prospects.
The U.S. household sector is showing rapid growth in most types of savings. At $27.5 trillion,  U.S. households have more net
financial assets than the rest of the world combined. By this measure, IMF data shows
Japan with $9.5 trillion, the UK 
$4.3 trillion, Germany $3.2
trillion, and   France
$2.6 trillion. Having added $1.5 trillion over the last four quarters,  U.S.   households probably also added
more to financial savings than the rest of the world combined.  This measure includes mortgages and credit cards in debt but
excludes houses in assets, so broader definitions would be even more favorable to the U.S. In the third quarter, household
net worth rose $776 billion to $54.1 trillion. Financial net worth increased
$479 billion to $27.5 trillion. Household liabilities rose $268 billion to $13.0

Briefly put, household balance sheets are very strong and getting stronger.  If one were to add gains in home values for the last several years, the picture would be even better.  Please note that the gains in household net worth dwarf the alleged impacts from housing declines and sub-prime mortgages.  Do yourself a favor and bookmark this page.  The next time you see one of the doom and gloom articles, please check back here and compare the (exaggerated) numbers from anecdotes with the overall household strength.

Malpass concludes, both in this piece and in various others, that household net worth or home equity withdrawals are not key drivers of consumption.  He cites the low unemployment rate and the "rapidly rising personal income."

Anyone who has been paying attention to how personal savings and debt are measured understands the flaws in the highly-publicized reports.  The government clarified this years ago, pointing out the shortcomings.  Readers of James Altucher on theStreet.com’s RealMoney site learned this through his excellent analysis of these measures.

(Part of the "debt fuel" argument is about the U.S. national debt.  More on that in our next post.)

Reaching the right investment conclusions often starts with figuring out where to get the evidence and knowing how to find those who are expert.  Our guidelines will help with this.

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  • RB April 3, 2007  

    “The multi-decade accumulation in U.S. household assets, not reflected in the personal savings rate which excludes gains, is a key factor in the economy’s sturdiness and strong long-term prospects.”
    When looking at the national savings rate, don’t you still need someone with liquid cash (excluding foreign buyers) in the bank to be able to realize the increase in asset value? So, why is the negative savings rate irrelevant?

  • Larry Nusbaum April 3, 2007  

    “So, why is the negative savings rate irrelevant?”
    Depends on how it is defined. For many it is utter disaster. For others, their “savings” may be substantial, but in the forms of hard assets such as property or precious metals.
    I have often argued that a rental house is absolutely a “savings” vehicle. And a forced (disciplined) one at that.
    One other reason why cash may not be all that important: easy access to funds through a HELOC.
    One more point: the debt as a % of income is meaningless if we don’t measure (and we can’t) passive forms of income (which so little is reported and much that is reported is sheltered.

  • RB April 3, 2007  

    Since we are talking about the national savings rate — in aggregate, excluding foreign buyers, can the available HELOC be used to convert a negative savings rate into a positive one? Where are the buyers with cash for the sellers of financial assets (mortgage bonds/stocks/real estate property)? Let’s say X put down 100 dollars of HELOC into a mutual fund from Y. X has the financial asset, Y has the cash. Cash is conserved. Why then is the savings rate negative? Is this where the bears’ observation of a debt-financed lifestyle off the savings of foreigners comes in? Or is there some other dark matter?

  • EVANS DEVELOPMENT June 8, 2007