Americans’ Debt Mess Is a Real Balancing Act
Consider now the debt mess. Americans, it is said, have overborrowed. We have hocked ourselves up to our eyelashes. The staggering debt is said to threaten the economy. But if mass retrenchment tips it into recession, then things will only get worse. Higher unemployment and more business bankruptcies will compound the problems of debtors. It’s scary, but is it true?
Granted, it sounds plausible. Americans love credit, and our economy constantly devises new ways to borrow. Nor is there any doubt that bad loans have hurt financial institutions, from the Bank of America to many smaller savings-and-loan associations. The Federal Deposit Insurance Corp. (which insures deposits at most banks) reports that about 10% of banks are on its problem list.
But the problems of debt may be exaggerated. They’re more the symptom than the cause of a weak economy. Business investment hasn’t slowed because companies are overloaded with debt. It has slowed because demand is soft, and demand isn’t soft because consumers have suddenly retrenched. It’s soft because the huge trade deficit has drained too much of Americans’ spending into imports without providing an offsetting export demand.
Few subjects are as mystifying as debt. The ultimate authority is Charles Dickens’ Micawber, who said: “Annual income 20 pounds, annual expenditure 19 pounds six, result happiness. Annual income 20 pounds, annual expenditures 20 pounds ought and six, result misery.” Micawber’s insight applies to debt: The only sure sign of a bad loan is when someone doesn’t pay. If there were other fail-safe tests, bad loans would never be made. Elaborate financial statistics don’t conclusively say whether individuals or companies have overborrowed.
The debt problem is further muddled because it is many problems rolled into one: annual federal deficits (which increase the federal debt), the Latin American debt crisis, U.S. farmers’ debts and the general debts of other U.S. businesses and consumers. All these debt problems are not the same.
A huge part of today’s bad-debt problem reflects the tortuous transition from the 1970s’ high inflation. Farmers, developing countries and oil producers all borrowed on the assumption of rising prices for their products--whether wheat, copper, oil or sugar. The prospect of higher prices made new debts seem manageable; producers’ incomes would be rising, and therefore paying off debts would be easy. When prices fell instead, servicing these debts became difficult, if not impossible.
The recent oil-price collapse is simply the latest phase in this process, and there are ripple effects. When oil prices drop, many of the buildings built to accommodate an expanding oil industry go empty. Loans made on them then go sour. Farm suppliers get into trouble along with farmers. Companies that had large export markets in developing countries suffer when these countries can’t afford to import.
What is disquieting now is that there seems to be a general buildup of debt outside these troubled sectors. Relative debt levels seem to be rising. The Federal Reserve reports that between 1980 and 1985 the nation’s total debt, now $6.9 trillion, grew faster than the gross national product, rising from 138% to 169% of the GNP. The debt of non-financial businesses has risen from 26% to about 32% of their total investment. Household debt, mainly mortgages and installment loans, jumped from 72% to 83% of disposable income.
The ultimate horror of overindebtedness, as economist Irving Fisher noted in a famous 1933 essay, is a snowballing economic collapse. Bankruptcies feed on themselves. Creditors are thrown into insolvency by bad loans, and as the economy worsens more debtors can’t pay. Prices decline, which makes repayment of loans taken out when prices were higher even more difficult. Fisher thought this cycle the cause of the Great Depression.
Fisher’s theory poses an obvious question for today: Are debt levels so large that many borrowers won’t be able to repay? In this respect the federal debt is the least worrisome. People and institutions that hold Treasury bonds won’t be instantly wiped out, because the federal government isn’t about to default. At the other extreme are the debts of many farmers and developing countries. Whether or not they have been declared in default, many of these borrowers clearly can’t repay. In the middle are the mass of consumers and businesses. Can they handle their debts?
The figures cited above settle nothing. There are complicating factors. Total consumer debt has risen, but interest rates--especially on mortgages--have declined, reducing monthly payments. Longer maturities on car loans also mean lower monthly payments. The rise in business debt may be concentrated among a relatively small number of firms involved in mergers or in leveraged buyouts.
But debt problems will get worse if the economy gets worse. In the 1930s Fisher argued that the Depression could have been stopped if the Federal Reserve had kept credit easy enough to prevent a few debtors’ problems from becoming a general collapse. The Fed’s job today, although similar, is complicated by two realities: First, the economy is still vulnerable to inflation; the trick is to keep credit easy enough to promote growth without reigniting inflation. Second, the Fed doesn’t directly control the economic policies of other countries. It’s a balancing act worthy of Micawber.
