Too Much Debt
From Martin Wolf at The Financial Times.
The aggregate stock of US debt
rose from a mere 163 per cent of gross domestic product in 1980 to 346
per cent in 2007. Just two sectors of the economy were responsible for
this massive rise in leverage: households, whose indebtedness jumped
from 50 per cent of GDP in 1980 to 71 per cent in 2000 and 100 per cent
in 2007; and the financial sector, whose indebtedness jumped from just
21 per cent of GDP in 1980 to 83 per cent in 2000 and 116 per cent in
2007 (see charts). The balance sheets of the financial sector exploded,
as did the sector’s notional profitability. But leverage, alas, works
both ways.
Since US net international debt was 39 per cent of GDP at the end of 2007, virtually all of this debt is an asset of another domestic entity and would net out to zero. But when the gross debt stock is huge and economic conditions difficult, the chances that many entities are bankrupt is high. When people fear mass insolvency, lenders stop lending and the indebted stop spending. The result can be the “debt deflation”, described by the American economist, Irving Fisher, in 1933 and experienced by Japan in the 1990s.
Given the recent explosion in leverage, the challenge is unlikely to be one of mispricing of the toxic mortgage-backed securities alone. Many people and institutions made leveraged bets that have since gone sour. Their debt cannot be repaid. Creditors are responding accordingly.
Via Paul Kedrosky.
»
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