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Monday, December 7, 2009

Deleveraging Consumer and Economic Growth

Consumer credit continues to decrease. WSJ reports:

Consumer lending shrank 1.7% in October, the ninth consecutive drop, extending the dramatic decline of financing available to help fuel the U.S. economy.

The $3.5 billion decline, calculated by the Federal Reserve, caps a 4% drop in consumer lending from its July 2008 peak. Before then, borrowing by U.S. consumers -- including credit-card debt and auto loans, but excluding mortgages -- had been growing for more than a half-century.

Consumer activity accounts for about two-thirds of U.S. economic growth. Curtailed lending to consumers could hurt the chances for a strong recovery.
Until the recent crisis, consumer credit had exploded, now accounting for ~17% of nominal GDP, about twice the level from 50 years ago. All in, household debt is now more than 120% of GDP, twice the the level of just 25 years ago.

At some point this trend NEEDS to reverse course. Can it grow again before doing so? Sure, but that would push the level to a level even more unsustainable (and painful to correct).

So... if it were to change course, there are two ways this can happen:
  • Option 1a: Decrease the numerator (consumer credit outstanding) via reduced borrowing
  • Option 1b: Decrease the numerator (consumer credit outstanding) via default
  • Option 2a: Increase the denominator (nominal GDP) via true growth (i.e. real GDP)
  • Option 2b: Increase the denominator (nominal GDP) via inflation
Option #2a is unlikely. The reason? Consumer credit drives real GDP growth.

Long Term Trend


So deleveraging or inflation? I know the preference by policy makers, but it is awfully hard to get inflation in the face of a deleveraging consumer.

Source: Federal Reserve / BEA