consumer spending en-US Peak Debt <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/peak-debt" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="" alt="Going out of business sign" title="Going Out of Business" class="imagecache imagecache-250w" width="250" height="190" /></a> </div> </div> </div> <p>Is there a limit to how much Americans can spend?  Clearly there is:  All they earn, minus savings and service on their existing debt, plus new borrowing.  Since the Bureau of Economic Analysis puts numbers on those very items, it&#39;s possible to see just how close we are to the edge.  In a fascinating paper, Ron Laszewski does exactly that.  The results are rather depressing.</p> <p>Laszewski has kindly let me post his <a href="">peak debt paper</a> itself on my personal website, so you can read it yourself.  What follows here is a quick look at his conclusions (with just a glimpse of the math that&#39;s in the paper).<br /> <h2>Quick overview of the analysis</h2> <p>Basically, what Laszewski does is turn that simple statement of the limit to spending--all you earn, minus saving and debt service, plus new debt--into an equation.  Then, he fits that equation to the historical data from the <a href="">Bureau of Economic Analysis</a>.</p> <p>Since income has been flat since the 1970s, increases in spending since then have had to come from somewhere else.  They came first from a decline in saving, and then from an increase in borrowing.  (Not surprisingly, these changes went hand-in-hand with a decline in interest rates.  If there&#39;s scarcely any return to savings, why save?  If there&#39;s scarcely any cost to borrowing, why not borrow?)</p> <p>In about 2005, though, the &quot;new borrowing&quot; term hit its maximum.  According to the data, Americans as a group had, by then, reached the peak in the rate at which they could take on new debt.  Unable to take on new debt at an increasing rate, growth in spending would have to shrink--and that is exactly what the data show.<br /> <h2>What does it mean?</h2> <p><img src="" alt="Graph of consumer purchasing power" title="Consumer Purchasing Power" width="400" height="268" align="right" />The depressing results that I mentioned at the beginning go beyond just a decline in the growth of consumer spending.  Under any plausible scenario, consumer spending actually drops--and, in fact, drops by quite a bit.</p> <p>Since consumer spending is a large fraction of the economy, a drop in consumer spending inevitably means a recession.  The analysis in this paper suggests a rather severe one.  </p> <h2>Alternatives</h2> <p>When I read an early draft of the paper, I suggested that things wouldn&#39;t really go along this path--people wouldn&#39;t just let the enormous debt load grind them down.  Instead, we&#39;d see a mixture of ways to eradicate the debt without paying it off (some combination of inflation and defaults of various kinds--restructurings, bankruptcies, debt holidays, etc.).</p> <p>Assuming that this little model reflects reality, it turns out that none of these things really make much difference.  Under every scenario that we&#39;ve been able to think of, consumer spending declines sharply--and remains depressed for decades.</p> <h2>A model</h2> <p>It&#39;s important to note that what Laszewski has created is a <strong>model</strong>.  It&#39;s a little toy version of the economy that you can make changes to and set to run and see what the economy might look like.  The actual economy is a real thing.  Whether the model reflects reality remains to be seen.</p> <p>However, after doing his initial analysis, Laszewski found some data on residential mortgage debt between 1913 and 1940, which let him do a similar analysis for that period.  Fitting the curves to that data shows that America hit peak debt in 1925, with the great depression setting in about 5 years later.  The equations fit the data very nicely--one piece of evidence that the model may well reflect reality.  (Laszewski&#39;s analysis is in Appendix A in the paper.)</p> <p>People who are familiar with the model of &quot;peak oil&quot; will see certain parallels here--because the data turns out to fit a logistic curve (as does growth oil production)--a fact that Laszewski notes in the text:</p> <blockquote><p>The shape of the rise in total debt shown is also very well fit by the logistic growth equation.  The rate-of-change in the logistic growth curve implies that new borrowing probably reached its peak in 2005 and is now in decline.  We will refer to the peak in the rate of accumulation of new debt as Peak Debt, in conformity with the popular use of the designation “Peak Oil” to refer to the maximum in the rate of petroleum production. </p></blockquote> <h2>What to do?</h2> <p>As far as what to do in managing your affairs, I&#39;m afraid I don&#39;t have much in the way of new suggestions.  Certainly, avoid running up new debt of your own.  Be concerned that many other people&#39;s debt is not all going to be paid back, and let that fact guide your decisions about where to invest.</p> <p>Arranging your life so that a sharp and long-lasting decline in consumer spending won&#39;t destroy both your job and your investments at the same time is a most excellent idea--I wish I were in a position to give you some more specific suggestions about just how to do that.</p> <p>If you&#39;re at all interested in the math, I strongly suggest that you read the <a href="">peak debt paper</a>, rather than relying on my analysis.</p> <br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="">Philip Brewer</a> of <a href="">Wise Bread</a>, an award-winning personal finance and <a href="">credit card comparison</a> website. 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