Download Determining How Careful We Need to be in Managing Our Debts

Proceeding with Caution: Determining How Careful We Need to be in Managing Our Debts
Forrest Scott Brinkley
Economics Major
October 13, 2006
With the progression of the1920s, American consumers became more and more
liberal with respect to their spending habits. Their wages had not increased in
accordance with their spending habits, but financing durable goods had also come into
play. Installment plans paid for much of what was bought in the 1920s. When this buying
option was taken away along with the most Americans’ savings with the dawn of the
1930s, consumerism and the U.S. GDP died simultaneously. Today we have a similar
situation, though we’ve added the concept of revolving debt. Given this new debt, are we
headed toward the second Great Depression? While consumer debt has been rising and
the GDP again relies rather heavily on consumer spending for its wealth, the scenario is
not likely to repeat itself. We are safer because of the rules and regulations passed after
the Depression, but a look back at the Titanic’s fate reminds us that we are never
absolutely safe. We must continue governmental regulation of the credit industry in order
to prevent future devastation.
I.
Introduction
Americans are (and have been for some time) dependent upon credit. The consumer centric
society we now live in is almost a mirror of the 1920s. During this decade, consumer credit as a system of
buying and selling goods was used by the masses in the form of installment plans. We have similar
systems today that are used almost as frequently. What portion of the U.S. population is currently in debt
(excluding mortgage debt) and what risk(s) are associated with this figure?
To determine risk factors in this situation where people are spending banks’ and lenders’ monies,
one must look to history. In the years leading up to the Great Depression, there was a large supply of
loans available from banks acting as middlemen to the consumer. When these smaller banks failed left
and right after the market collapse in 1929, there was a reduced supply of low-cost loans to consumers.
Thus the price of loans rose, and fewer and fewer could afford to borrow. “Most affected were
households, farmers, unincorporated businesses, and small corporations.” (Temin 1989).
Similarities between the Roaring ‘20s and contemporary times make the risks even clearer. In the
1920s, what had been considered luxurious prior to WWI was now commonplace. “The consumer
economy evolved into a vast engine fueled by buyer demand.” (Klein 2001). Today, as in the 1920s,
much of the economy is based upon consumers buying goods and services, with or without their own
money. Approximately 71% of the 2005 U.S. GDP was based on consumer expenditure. (Carter 2006).
(Billions of USD)
Total Consumer
Debt
Revolving Debt
Real GDP
Consumption Exp.
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
1095.8
443.1
8031.7
5433.5
1183
499.4
8329
5619
1235
531.2
8704
5832
1301
560.5
9067
6126
1393.7
595.6
9470.3
6438.6
1534
663
9817
6739
1905
742.9
9891
6910
2013
762.9
10049
7099
2118
784.8
10301
7307
2233
818.7
10704
7589
2322
842.1
11049
7841
67.7%
67.5%
67.0%
67.6%
68.0%
68.7%
69.9%
70.6%
70.9%
70.9%
71.0%
20.2%
21.0%
21.2%
21.2%
21.6%
22.8%
27.6%
28.4%
29.0%
29.4%
29.6%
8.2%
8.9%
9.1%
9.1%
9.3%
9.8%
10.8%
10.7%
10.7%
10.8%
10.7%
1919
1920
1921
1922
1923
1924
1925
1926
1927
1928
1929
26.34
637.85
583.75
26.46
555.1
575
22.85
443
560.9
27.29
477.1
594.4
33.67
563.28
673.49
35.76
560.7
690.1
41.94
608.8
711.8
45.27
625.4
755.3
45.68
620.5
763.6
55.35
655.4
769.9
63.2
689.5
822.2
109.3%
96.5%
79.0%
80.3%
83.6%
81.3%
85.5%
82.8%
81.3%
85.1%
83.9%
4.1%
4.8%
5.2%
5.7%
6.0%
6.4%
6.9%
7.2%
7.4%
8.4%
9.2%
Calculations
Consumption's Role
in GDP
Debt's Role in
Consumption
Revolving Debt's
Role in Consumption
(Billions of USD)
Total Consumer
i
Debt
Consumption Exp.ii
Real GDP
Calculations
Consumption's Role
in GDP
Debt's Role in
Consumption
Total Consumer Debt
Debt in Billions of USD
70
60
50
40
30
20
10
0
1919 1920 1921 1922 1923 1924 1925 1926 1927 1928 1929
Year
Figure 1: Data Source: Historical Statistics of the United States
Table 1
Consumer spending and debt rose as the 1920s progressed.
Similarly, the total debt has increased sharply over the past five years. Weekly and hourly wages have
not quite caught up with the times and, as a result, people are borrowing more. Much of those funds
come from the value of consumers’ homes. (Eisinger 2006). Revolving debt has seen increases in the
past few years as well.
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
900
800
700
600
500
400
300
200
100
0
1995
Debt in Billions of USD
Revolving Debt
Year
Figure 2: Data Source: http://www.federalreserve.gov
It seems like every American these days is spending instead of saving. 132 percent of American
households’ disposable incomes have been dedicated to debts. (Greenhouse 2006).
II. Economic Model
What is inherently wrong with the present situation? One cannot guarantee the future, but he can
always look into the past for clues. Much of the economic failure in the Great Depression’s earliest
months came from the sharp decline in consumer spending experienced in America. In an economy so
dependant upon consumer spending (over three quarters of 1929s GDP was from such expenditure), any
significant drop in spending spells disaster. That is exactly what happened as 1930 progressed. The drop
in consumption occurred because of a decade of record high consumer debt and severe default
consequences. Although Americans did not stop spending all together in 1930, they slowed their
expenditures to ensure repayment of their debts in uncertain economic times. (Olney 1999).
The sense of uncertainty and the resulting reduction of consumer expenditure twisted ‘round in
the belly of the Bull the dagger that had been so violently stuck there in October of ’29. “The change was
neither immediate nor pervasive, but as the sense of uncertainty spread, it fed the uneasiness of those
who had already grown apprehensive about the economy.” (Klein 2001).
Would such a drop in spending be met with similar results in today’s economy? Today over 70%
of the U.S. GDP comes from consumer expenditure iii. Clearly it would be devastating if there were to be
such a sharp reduction in spending. Yet there are differences between the 1920s economy and the
contemporary economy that ought to calm all but the most pessimistic Americans. While there is a rather
large proportion of the GDP that comes from consumer expenditure, the number is significantly lower
than the figure right before the Great Depression.
Additionally, the U.S. government has significantly more power today than it did in 1929. “In 1929,
federal expenditures accounted for a mere 2.5% of the GNP, compared with 22% in 1990. It employed
only 579,559 people and operated no social programs.” (Klein 2001).
When the stock market crashed, the Federal Reserve System was legally independent of the
credit market and thus had no ability to control it. The laissez faire attitude held by so many at the time
viewed even this limited a government as too big. One might propose that the only similarities between
the pre-Depression U.S. government and the contemporary U.S. government are the Constitution and the
Bill of Rights. The legal authority held by today’s government over the economy is much greater and,
consequently, so is its ability to stop the next Depression.
Although Americans have been incurring an increasing amount of debt, the rules and regulations
put into effect after the Great Depression will prevent the recurrence of any adverse economic effects,
direct or indirect, that such debt had on the economy of the late 1920s.
III. Data Description
In analyzing the data supporting this hypothesis one notices two things. Firstly, when turning to a
graph of consumption as a percentage of GDP (see Figure 3) iv, one realizes that today’s consumption is
not as significant a factor in the U.S. economy. That is not to say that consumers are no longer a major
contributor to the U.S. economy (in fact they are the largest), but rather that other factors are present.
Such factors could help stabilize the U.S. economy in the event of a modest drop in consumer spending.
The economy would not be healthy, but we would not be seeing a recurrence of the Great Depression,
either.
Secondly, when one examines debt as a contributor to consumptionv, he will find that the slope of
the graph has become less steep in the past two to three years after the huge jump during the recession
earlier this decade. People are still spending quite a bit of lenders’ monies, but they have apparently
curbed this habit. 1920s consumers seemed to be increasing their debts without end. Simple visual
analysis of the slopes gives one this impression.
The significance of these data becomes quite clear when comparing and contrasting the
contemporary and 1920s U.S. economies. First of all, because of the Keynesian policies enacted during
the 1930s and 40s, we now have a smaller percentage of the U.S. GDP dependant solely upon consumer
expenditure. Consumer expenditure is still the most important part in terms of percentage, yet other
components such as government expenditure are now present to stabilize the system.
Secondly, for one particular reason or another, the amount of debt people are incurring with the
purchase of goods and services seems to be increasing at a slower rate. Indeed, it looks as if there will
be a decrease sometime in the near future.
Personal Consumption's Role in GDP
100.00%
80.00%
Consumption's Role
in GDP
60.00%
1920s Comparison
('19-'29)
40.00%
20.00%
Year
Figure 3vi
20
05
20
03
20
01
19
99
19
97
0.00%
19
95
Percent of GDP
120.00%
Debt's Role in Consumption
35.00%
30.00%
Percent
25.00%
Debt's Role in
Consumption
20.00%
15.00%
1920s Comparison
Data ('19-'29)
10.00%
5.00%
19
95
19
97
19
99
20
01
20
03
20
05
0.00%
Year
Figure 4vii
IV. Conclusion
Given the evidence that there is less a proportion of the U.S. GDP dependant upon the consumer
expenditure today with a slower increase in indebtedness related to this consumption, Americans are
much less likely to experience another depression caused or aided by these factors. The Federal
Reserve and today’s credit industry regulations are both sources of this increase in stability.
Credit scoring and government regulation on interest rates and minimum credit card payments are just a
few of the differences between 20s credit markets and today’s. One source of stability today is the powers
granted to the government by Congress in the 1930s and 40s.
The Federal Reserve, the BEA and other monitoring and regulatory agencies were all created
and or strengthened after the Great Depression. Theoretically, at least, agency monitoring would detect
instability. Congress could then make the necessary changes in government spending to curb the effects
of any potential economic disaster.
Just as the Titanic’s flood-safe doors were a deceiving safety feature, care must be taken when
relying on Uncle Sam to keep tabs on the consumer credit industry and its effects on the economy. The
government must be careful not to allow debt’s role in consumption to rise to unsafe levels. Consider an
economy where 100% of consumer expenditures were made with lenders’ dollars. The Great Depression,
Part II would be a market panic away.
Not all government solutions work, either. The government essentially has two options at all
times. Option one is to decrease spending through tax cuts. The alternative would be to funnel more tax
dollar into programs aimed at recovery. Depending upon the type of problem with the economy, either
option could be beneficial. Yet Congress is full of politicians who are susceptible to political forces, not
economic forces. The right option can sometimes be very hard to determine under such biased
conditions.
Fortunately as of now, Congress seems to have chosen the right option. According to BBC News,
the U.S. federal deficit has fallen due to higher employment rates making more people eligible for
taxation. No doubt, these same newly-employed citizens also have more cash to spend in place of the
credited dollars they used while unemployed.
Americans and their government are now smarter than ever about the U.S. economy. They have
learned from the Great Depression. Many of the factors that caused the market downfall in 1929 have
now been outlawed. The U.S. economy is not perfect, but it is substantially more stable and than it was in
the pre-Depression years.
References
Carter, Susan B. Scott Sigmund Gartner, Michael R. Haines, Alan R. Olmstead, Richard Sutch, and
Gavin Wright, eds. 2006. Historical Statistics of the United States: Earliest Times to the Present.
Vol. 3. Part C: Economic Structure and Performace. New York, NY.: Cambridge University Press.
Eisinger, Jesse. Long and Short: Night of the Living Debt. The Wall Street Journal. 4 Jan. 2006.
Greenhouse, Steven. Borrowers We Be. The New York Times. 3 Sept. 2006.
Klein, Maury. 2001. Rainbow’s End: The Crash of 1929. New York: Oxford University Press.
Olney, Martha J. 1999. Avoiding Default: The Role of Credit in the Consumption Collapse of 1930.
The Quarterly Journal of Economics 114, no. 1: 319-335.
http://www.jstor.org. (Accessed September 30, 2006).
Tax Bonanza Helps Cut U.S Deficit. BBC News. 11 October 2006.
http://news.bbc.co.uk/2/hi/business/6041460.stm. (Accessed October 13, 2006).
Temin, Peter. 1989. Lessons from the Great Depression. Cambridge: MIT Press.
i
Please see note ii.
Please note that this data was calculated with the inflation calculator at:
http://www.westegg.com/inflation/ . Thus, it is not directly comparable to the RGDP data for the 1920s,
which was calculated for 1996 with the chained-dollar method. Therefore, the percentages calculated for
consumption’s role in GDP ought not to be taken too literally. They were included for illustrative purposes
only. Chained dollar values were not available for this data set.
iii See Table 1.
iv See Figure 3.
v See Figure 4.
vi Please see Note i.
vii Please see Note ii.
ii