Government Debt Isn't the Problem—Private Debt Is

From the Atlantic

Government Debt Isn't the Problem—Private Debt Is
The Roaring Twenties, the Japanese boom of the '80s, and the U.S.'s in the early 2000s have one thing in common: They were debt-fueled binges that brought these economies to the brink of ruin.

RICHARD VAGUE | SEP 9 2014

Former Fed Chairman Alan Greenspan, discussing the financial crisis of 2008, wrote that “financial bubbles occur from time to time, and usually with little or no forewarning.”

That’s misleading at best. The 2008 collapse was predictable. And, more generally, major financial crises of this type can be seen well in advance—and prevented—if you know what to look for. In fact, there’s a fairly simple formula that predicts such crises with a high amount of confidence. And it suggests that the world economy remains in more peril than is generally appreciated.

This conclusion comes from an examination of financial crises around the world, dating back to the 19th century, that I conducted with my colleagues and summarize in my new book The Next Economic Disaster. The logic behind our conclusion can be seen in the diagrams below.

Take a look at this graph:

Crisis of 2007-2008: U.S. GDP, Public Debt, and Private Debt (in Billions)

GDP data comes from the Bureau of Economic Analysis, private-debt data from the Federal Reserve, and Federal-debt data from the Treasury. (Richard Vague)

Note that, in the years prior to the crisis, the line representing federal government debt roughly parallels the line representing GDP; federal debt wasn’t growing dramatically as a fraction of GDP. So the big post-crisis standoff between Democrats and Republicans over the federal debt wasn’t focused on the big problem.

What was the big problem? Look at the line representing private debt. It clearly is not parallel to the GDP line and, indeed, reflects a rapid growth of private debt relative to GDP.

By itself this isn’t shocking. We all know that a growth in home mortgages preceded the crash, and home mortgages are one kind of private debt—along with other consumer borrowing and borrowing by businesses. What’s more surprising is what we found when we looked at lots of other financial crises around the world, dating back to the 19th century: Though most of these crises aren’t thought of as being fundamentally caused by excessive private debt, the fact is that they were preceded by the same kind of runup in private debt that the U.S. saw prior to 2008. 

Just to take one example, look at this data from Japan prior to its financial crisis of 1991. 

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