According to research, sectors of the American economy are building to a bubble of parallel and possibly larger scope than the conditions preceding the 2008 financial crisis. Photograph: Tony O’Brien/Action Images
By Dimitri Papadimitriou
Originally published by The Guardian.
Forces that caused the world economy to collapse, including income inequality and debt, are again in action, and could drag corporations down in their wake
The US Congressional Budget Office is projecting a continued economic recovery. So why look down the road – say, to 2017 – and worry?
Here’s why: because the debt held by American households is rising ominously. And unless our economic policies change, that debt balloon, powered by radical income inequality, is going to become the next bust.
Our macro models at the Levy Economics Institute are showing that the US economy is about to face a repeat of pre-crisis-style, debt-led growth, based on increased borrowing. Falling government deficits are being replaced by rising debts on everyone else’s ledgers – well, almost everyone else’s.
What’s emerging is a new sort of speculative bubble, this time based on consumer and corporate credit.
Right now, America is wrestling a three-headed monster of weak foreign demand, tight government budgets and high income inequality, with every sign that these conditions will continue. With that trio in place, the anticipated growth isn’t going to be propelled by an export bonanza, or by a government investment boom.
It will have to be driven by spending. Even a limping recovery like the one we’re nursing along today depends on domestic demand – consumer spending not just by the wealthy, but by everyone else.
We believe that Americans will keep consuming at the same ever-rising rates of past decades, during good times and bad. But for the vast majority, wages and wealth aren’t going up, so we’re anticipating that the majority of Americans – the 90% – will once again do what was done before: borrow, and then borrow more.
By early 2017, with growth likely to stall even according to CBO predictions, it should be apparent that we’re reliving an alarming history. Middle- and low-income households have been following a trajectory of an ever-higher ratio of debt to income. That same ratio has been decreasing for the most well-off 10%, who are continuing to see debt decline and wealth rise.
Why is the relationship between the debt of the 90% and the gains of the 10% so significant?
The evidence demonstrates that the de-leveraging of the very rich and the indebtedness of almost everyone else move in tandem; they follow the same trend line.
In short, there’s a strong and continuous correlation between the rich getting richer, and the poor – make that the 90% – going deeper into debt.
That the share of income and wealth to the richest has skyrocketed is certainly not a new revelation. The heralded data tabulations of Thomas Piketty and Emmanuel Saez have demonstrated just how spectacular the plutocrats’ portion became in the run-up to the Great Recession. They codified the belief that no one else can ever catch up with the very wealthiest.
One important explanation for that consolidation of wealth emerged from our latest research: The more – proportionally – that the top 10% has prospered, saved and invested (naturally, the gains found their way into the financial markets), the more the bottom 90% has borrowed.
Look at the record of how these phenomena have travelled in lockstep. In the first three decades after the second world war, the income of the 90% rose at the same pace as its consumption. But after the mid-1970s, a gap formed – the trend lines on earning and outlays spread apart. Spending continued apace. Real income, meanwhile, stagnated. It was lower in 2012 than it had been forty years earlier. That ever-increasing gap between income and consumption has been filled by borrowing.
These were the debt dynamics in the lead-up to the recession. But they are also the dynamics leading out of the crisis, and continuing today with no end in sight.
Before and after the crash, the fortunes of the most fortunate sped upward. Between 1983 and 2010, for example, the richest 20% increased in wealth by 100%. But their proportion of debt to wealth fell.
The bottom 40%, meanwhile, lost 270% in wealth.
It was much applauded when households began to rapidly pay down debt after 2007. And yet, despite this, their debt to equity ratio actually rose. With incomes plunging and the value of their assets – notably, housing – in a free-fall, they couldn’t de-leverage fast enough. Debt outpaced everything else.
Insolvency for the 90% – the overwhelming majority of Americans – has become, in the decade’s catch phrase, “the new normal”. Unsustainable? Of course.
The debt picture is also changing dramatically for corporations. Historically, the private sector, which often goes by the moniker Corporate America, had not, overall, been borrowers. They increased their revenues far more than they borrowed money. Their net lending was exceptionally low, hovering at around 4% of GDP between 1960 and the mid 1990s.
After the crisis, corporations, like households, pulled way back on borrowing. But, also like households, they are now increasing their debt. The steep rise began for non-financial corporations in 2010 (for families and individuals, debt levels began to go upwards again in 2013). We think these businesses will add another $4tn of debt between now and 2017.
Under the current disastrous economic and tax policies, we can look forward to rapid increases in debt for both corporations and households from at least 2015 to 2017: a tsunami of debt.
Alternatively, a teeth-gritting brake on household and corporate spending would be no help at all.
That’s because if levels of debt and consumer consumption go down, the nation would move into what’s called secular stagnation: anemic growth, if any, and higher unemployment. The CBO projections for growth can’t possibly be met unless Americans take on massive liabilities, piling debt upon debt. Without debt accumulation, there wouldn’t be enough demand – spending – to keep the economy moving.
To paraphrase Voltaire’s words on God, even if bubbles and debt did not exist, it would be necessary to invent them. And that is exactly what we are doing.