The Federal Reserve keeps track of household debt in the U.S, and its latest numbers are alarming a lot of analysts. Driven by consumer credit, in the fourth quarter of 2017 household debt grew 5.2 percent, the fastest rate since just before the financial crash of 2008.
At the same time, though, household wealth set a record. In the fourth quarter of 2017, household net worth (total assets minus total liabilities) rose to nearly $100 trillion. With net worth growing at such a healthy pace, should we assume that everything is OK or should we be worried about the debt?
The answer is yes.
Looking at the key variables, everything is OK in the economy, the best it has been in over a decade. The employment picture is very good, inflation remains at manageable levels, economic growth is healthy and improving, and incomes are going up. There are no big worries there. The government debt picture is unattractive and must be addressed but it is not an immediate problem.
The increasing household net worth is a good thing, but we should still be worried about consumer debt. There are several reasons for this puzzling answer, and we can trace their roots to a significant gap in economic theory.
The first reason is the liquidity mismatch between the assets and liabilities that make up household wealth. The two principal components of household wealth growth are real estate and stocks. Real estate assets — household homes, primarily — are not at all liquid. Stocks are much more liquid, but under financial stress liquidity comes at the price of significant losses. And both the stock market and the real estate market have a vulnerability to bubbles that can vaporize financial gains in a short time.
Consumer debt, on the other hand, requires regular payments, usually every month, which drains household budgets of their liquidity. And it is this difference in liquidity that is worrisome and points to an enduring problem, a gap, in economic theory and economic policy.
Essentially, it is a relationship problem. In this case the problem is in the relationships between assets, liabilities, income and consumption.
When people make gains in the stock market, or their houses increase in market value, they “feel wealthier” and are more likely to increase their consumption expenditures. The increase in household wealth, though, was an asset increase, while their incomes remain the same. Increasing consumption, then, usually requires borrowing money and raising household debt. Feeling wealthier tends to dampen worries over increasing credit card debt, but it doesn’t help make the monthly payments. And at today’s interest rates on installment debt, households can find themselves aboard a liquidity treadmill.
The relationship between balance sheets and income statements is a gap in economic theory at both the individual behavior and national economy levels. Like most gaps that decision makers face, we have filled them in with the grout of historical experience, judgement, statistical comparisons and educated guesses. In areas of theoretical gaps more often than not economic policy consists of not worrying about what we don’t know, making policy decisions based on what we do know and letting the economy figure out the rest on its own.
A prime example of one of the gaps we’ve filled in is the rate of savings. If we sift through our economic policies past and present we pretty much draw a blank when it comes to what household savings rate we want, let alone specific policies of how we might achieve that. We set target rates for things like inflation and economic growth, but the savings rate, which is intimately linked to both of those areas, is rarely mentioned, much less targeted.
One of the few times in our economic history when household and individual savings were specifically targeted was during World War II. There the goal was simply to avoid inflation. By taking consumer discretionary income out of the market and into government debt instruments, economic policy makers hoped to suppress demand enough to keep prices under control.
James McCusker is a Bothell economist, educator and consultant.
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